CCA Further Clarifies “Interior” for Qualified Leasehold Improvement Property

Section 1.168(k)-1(c) of the Internal Revenue Code explains the statutory requirements for property to fall under the definition of qualified leasehold improvement property (QLIP).  In general, in order to qualify, the leasehold improvement must be made to an interior portion of a building occupied exclusively by the lessee (or sublesee), pursuant to a lease, and more than three years after the date the building was first placed in service. Property that meets these requirements through the end of 2013 receives beneficial tax treatment; the asset qualifies for 50% bonus depreciation in the first year and the remaining cost basis is depreciated over 15 years.

In a recent Chief Council Advice (CCA), there has been further clarification to the meaning of “interior” in regards to the requirements for property to be defined as QLIP.  In the case involving a retail tenant that installed HVAC units on the roof and on concrete pads adjacent to the building it leased, the IRS has concluded that the HVAC units will not qualify as QLIP since they are not in the “interior” of the tenant space. This conclusion mainly impacts heating, ventilation, and air conditioning units (HVAC) and their ability to accelerate depreciation.  The units are not eligible for first-year bonus deprecation and the cost recovery period is limited to 39 years, instead of 15 years.