Tenant improvements to apartment are tax deductible?

A friend of mine has to get a floor redone in an apartment he rents (water damage from leaky radiator). The landlord wants to redo it in the cheapest way possible by using linoleum tile, but my friend would like to put in a wooden tile floor which is more expensive. The landlord is willing to do that, but doesn’t want to pay for it and would charge my friend the difference in cost.

I told my friend that I recall some piece of the tax code that said if a tenant pays for a permanent improvement to the apartment that would remain with the landlord if the tenant moves out, this can be deducted form the tenant’s taxes. However, I can’t seem to find any reference to this (I’m remembering this from about 10 years ago, and it never applied to me, so maybe I am remembering incorrectly, or maybe the deduction doesn’t exist anymore).

Do any of you CPA guys know about this and can confirm or deny that? And if there is a reference to the rule or the part of the code, can you help me find a link that I can refer my friend to?

IRS Code Section 168 (i) (8) (B)

http://www.law.cornell.edu/uscode/text/26/168

“A lessor is entitled to recover the cost of depreciable leasehold improvements that it makes. If such improvements are made for the lessee AND are irrevocably disposed of or abandoned by the lessor at the termination of the lease by the lessee, then for purposes of determining gain or loss, the improvement is treated as disposed of by the lessor at that time.” (from the RIA Federal Tax Handbook)

Thanks Greenman, I thought you’d come through here…

So basically it is not deductible until the tenant moves out and “disposes” of it by leaving it with the landlord.

Is that the right interpretation of the legalese?

Yeah, that’s the way I read it. And when he does "dispose"of it, it will probably go on Schedule E, as a deduction from “rents received” (which will be zero).

No deduction to the tenant, unless the apartment is used for business. If it is used for business, then the cost is depreciated.

Are you looking at Code Section 109 and 110? Those are only for the lessee, and it does have to be used as a trade or business. Section 168 doesn’t have any such qualifiers.

Of course, tell me if I’m wrong.

Begun, the Code War has.

No I’m not looking at 109 and 110. Actually I’m trying to figure out how to dump my CPA practice and get as far away from the tax code as possible. But, since I’m still in that universe…

Sec 168 is ACRS for depreciable assets and I’m pretty sure you cannot depreciate a personal asset. If I’m wrong, then why can’t I depreciate my home theater system, my camera gear, and my house?

Thanks higgy, I actually lol’d at this.

^ It was a Star Wars day yesterday for some reason.

It’s not a personal asset. It’s a business asset. It’s rental property.

And should it be depreciated? The code specifically says “the depreciation deduction shall be determined under the provisions of this section.” Then it goes on to say that the loss should be taken “by the lessor when so disposed of or abandoned.”

And you CAN depreciate your camera gear! Set up a Schedule C photography business, and then you can depreciate your camera.

Deducting your home theater and house would be more difficult. If it were a second home (lake house, etc.), it would be easy to set it up as an “employee vacation destination” and call it an “employee benefit”. But if you live there all year long, it’s hard to justify vacationing in it.

EDIT - and I actually LOL’d at that too, Higgy.

Greenman, the tenant can depreciate the asset if it is used for business purposeses. Hank Moody is correct in that you cannot depreciate assets for personal use. Only if BChad’s friend uses the apartment for business may he then depreciate it.

Your code (Section 168) allows depreciation expense from Section 167 (a) which states:

(a) General rule

There shall be allowed as a depreciation deduction a reasonable allowance for the exhaustion, wear and tear (including a reasonable allowance for obsolescence)— (1)of property used in the trade or business, or (2)of property held for the production of income.

A CPA too, I am.

Yoda would’ve used “also” instead of “too” ==> You’re disqualified.

Would subletting the space qualify as a business?

Yes, but the very first provision in Code Section 168 says, “_ Except as otherwise provided in this section _, the depreciation deduction provided by section 167 (a) for any tangible property…”

It pretty plainly otherwise provides in this section when it says that the improvements, “shall be treated for purposes of determining gain or loss under this title as disposed of by the lessor when so disposed of or abandoned.”


At any rate, BChad, there you have it. And just like with everything else in the tax world, you can take the deduction until it gets audited and disallowed. I’ve provided a basis for my opinion, and so have the others, and we’ll probably disagree until the IRS audits it and allows/disallows it.

One thing is certain–the IRS will only allow the deduction if you actually take the deduction. Althought this seems like a tautology at first, there’s more to the saying than meets the eye.

That’s fine Greenman, I see your logic here. Anyway, he is probably willing to pay more for the wood floor, but the presence of a tax deduction might make it an easier decision for him to swallow. The only real issue if he takes it (aside from whether it would withstand an audit) is that he’d presumably have to wait to dispose of it, by which time it might not seem relevant to him.

Is it legal to sublet?

If it’s illegal, you can still deduct it! Just make sure it’s “ordinary and necessary”.

However, if you are trafficking illegal drugs, the only deduction you can take is Cost of Goods Sold. (Serious as the grave on this one.)

Interesting. Subletting is legal in terms of what the guy’s lease permits; however I don’t really know if he reports subletting as business income (I suspect he doesn’t but don’t know either way). So I suppose if taking the deduction would then raise a flag about unreported taxable income, that might not be something he would choose to do. In any case, I don’t have that level of detail.

It’s a valid question but to claim a loss from the TI’s, the activity has to be engaged in for a profit. If it’s a sublet, chances are that it’s a for reimbursement.

If there is a profit, are you reporting it? If so, then maybe the deduction can be claimed on Schedule E, but that deduction is probably limited to net profit.

I don’t recall from the original fact pattern that it’s a business asset – at least not in the hands of the tenant. Now, if there’s a home office, you can deduct a percentage…