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Construction Allowance

 

If you currently lease a retail space, or are planning to do so in the future, you should be aware that if certain requirements are met, when you, as a tenant, receive cash or rent reductions from the landlord, you do not need to include such amounts in your gross income for tax purposes, as long as you use these amounts for qualified construction or improvement to the interior of the leased retail space. Such amounts are known as "construction allowances."

 

The simplified tax treatment above applies to construction allowances that meet certain requirements (and which are paid under leases entered into after August 5, 1997).

 

What is a qualified construction allowance? A qualified construction allowance is any amount that the landlord pays to the tenant in cash or in the form of a rent reduction:

 

• Under a short-term lease of retail space for 15 years or less (retail space is defined as nonresidential real property that is leased, occupied, or otherwise used by the tenant in its trade or business of selling tangible personal property or services to the general public);

 

• For the purpose of constructing or improving qualified long-term real property for use in the tenant's trade or business at that retail space (qualified long-term real property is nonresidential real property that is part of or present at the retail space and that reverts to the landlord when the lease terminates); and

 

• To the extent that the allowance does not exceed the amount spent by the tenant for the construction or improvement.

 

Time limit. There is a limited time period in which the tenant must use the construction allowance. A construction allowance will generally be deemed a qualified construction allowance only to the extent that the tenant spends it in the tax year that it is received, for the construction or improvement of qualified long-term real property for use in the tenant's trade or business at that retail space.

 

In determining if the construction allowance is spent in the tax year received, a special 8 1/2 month extension is provided. An amount is deemed to be spent by the tenant in the tax year when the construction allowance was received if:

 

• it is spent within 8 1/2 months after the close of the tax year when the allowance was received; or

 

• the amount is the landlord's reimbursement for amounts the tenant expended in a prior year and for which the tenant has not claimed any depreciation deductions.

 

Example: Big Mall Co. and Simple Designs Co., a calendar-year taxpayer, enter into a short-term lease for retail space on November 1. Included in the lease is a provision for payment of a $5,000 construction allowance to Simple Designs. The allowance is received on December 31. In order for the allowance to be treated as a qualified construction allowance that is excludable from Simple Designs' income, it must be spent by September 15 of the following year on the construction or improvement of qualified long-term real property for use in Simple Designs' trade or business at that retail space.

 

As seen from the above discussion, there several factors to evaluate in determining if you would qualify for the simplified tax treatment of construction allowances. Please do not hesitate to contact this office if you have any questions regarding this issue. We would be happy to analyze your tax situation and advise you appropriately