April 04, 2011
Qualified Lessee Construction Allowances
As the economy slowly improves many tenants may be shopping for better lease arrangements from landlords or tenants may be looking for ways to improve existing property and might not have the funds to do so. Property owners may consider a common alternative utilized in retaining or attracting tenants by providing Qualified Lessee Construction Allowances.
In general, Qualified Lessee Construction Allowances are amounts received as cash or rent reductions provided to a lessee by a lessor, which are specifically provided under a lease agreement for constructing or improving qualified long-term real property used in a trade or business at a retail space by the lessee.
The benefit of this type of arrangement is two-fold:
- The lessee receives cash reimbursements or rent reductions from the lessor to improve the leased property and does not have to recognize taxable income for the amounts received so long as certain conditions are met.
- The lessor treats the cash payments or reductions to the lessee as nonresidential real property and is able depreciate the improved property under general tax depreciation principles.
There are several criteria that must be met by both the lessor and the lessee in order for the Qualified Lessee Construction Allowance to apply:
- The lease must be under a short-term lease, which is defined as 15 years or less, or other agreement for occupancy or use of retail space.
- The qualified property is nonresidential real property that is present at a retail space. Retail space is nonresidential real property used in a trade or business of selling tangible personal property or services to the general public. Services generally include hair stylists, tailors, doctors, lawyers, accountants, insurance agents, financial advisors, and bankers. Retail space does not only include space where retail activity is performed. It is also defined as additional space where activities supporting the retail activity take place, such as administration.
- Qualified real property must revert back to the lessor at the expiration of the lease.
- The lessor and the lessee who are paying and receiving the allowance must both furnish specific information with their timely filed federal income tax return (including extensions) for the taxable year in which the allowance was paid by the lessor or received by the lessee.
Qualified Lessee Construction Allowances can benefit both the lessor and the lessee. The lessor can attract or retain lessees while the lessee can avoid recognizing income from the cash received by the lessor for improvements.