The IRS has concluded, in a recent advisory notice, that the installation of heating, ventilation and air conditioning (HVAC) units outside of a building, or on its roof, is not eligible for qualified leasehold improvement (QLHI) treatment.
The Internal Revenue Code provides that the term QLHI property means any improvement to an interior portion of a building that is nonresidential rental property if:
- such improvement is made under or pursuant to a lease by the lessee or lessor of that portion,
- that portion is to be occupied exclusively by the lessee for the portion, and
- the improvement is placed in service more than three years after the date the building was first placed in service
Property meeting this criteria is allowed a 15-year recovery period and is also eligible for bonus depreciation. Other non residential leasehold improvements not meeting the above criteria would be subject to depreciation using the straight-line method with a 39-year recovery period (not eligible for bonus depreciation).
HVAC units do not meet the criteria for QLHI treatment, because the installation of an exterior HVAC unit is not considered an improvement to the interior of the building.
Other common improvements made inside a building that also do not meet the QLHI criteria include elevators and escalators. These improvements do not qualify as they are improvements that can be attributed to the enlargement of a building and are considered structural components that benefit a common area of the internal structure of a building.
If you are planning a renovation to your existing leased property, we recommend reviewing the plans with your Marcum Advisor to determine how to maximize the depreciation and bonus depreciation available.