Can You Claim Capital Allowances on Buildings?

Depreciation allows businesses to recover the cost of certain property over time. While the primary structure of a building typically does not qualify for immediate expensing, specific components or features within a building, and certain types of new construction or improvements, can qualify for this tax relief. These allowances reduce taxable profits, leading to a lower tax liability.

Types of Qualifying Expenditure

Many items within a building qualify as “tangible personal property” and can be depreciated. This includes assets such as heating, ventilation, and air conditioning (HVAC) systems, lighting fixtures, plumbing, electrical systems, and fitted kitchens in commercial properties. These items are generally depreciated over shorter recovery periods, often 5, 7, or 15 years.

“Qualified improvement property” (QIP) is another category of expenditures eligible for favorable depreciation. QIP is defined as any improvement made to the interior of a nonresidential building after it has been placed in service. This covers non-structural interior renovations, excluding building enlargement, elevators or escalators, and changes to the building’s internal structural framework.

QIP can qualify for bonus depreciation, allowing a significant portion of the cost to be deducted in the first year. Bonus depreciation percentages decrease annually and are scheduled to phase out in future years. If bonus depreciation is not elected, QIP is generally depreciated straight-line over a 15-year recovery period.

The cost of land is never depreciable because it does not wear out. The main structure of a building, unless it falls under specific improvement categories like QIP, is depreciated over a much longer period. Nonresidential real property, including commercial buildings, typically has a depreciation period of 39 years, while residential rental property is depreciated over 27.5 years. Both use a straight-line method under the Modified Accelerated Cost Recovery System (MACRS).

Identifying and Documenting Your Claim

Identifying qualifying items requires reviewing purchase contracts, construction invoices, and renovation costs. This helps segregate a property’s total cost into components with shorter depreciable lives, such as 5, 7, or 15 years.

Engaging a qualified cost segregation professional is beneficial for complex properties or significant renovations. These professionals perform a cost segregation study, meticulously analyzing the building and its components with expertise in construction, engineering, and tax laws. This study reclassifies portions of a property’s cost, normally depreciated over 27.5 or 39 years, into shorter recovery periods.

The IRS provides guidelines for cost segregation studies, emphasizing accurate classification and thorough documentation. A comprehensive report should detail the methodology, component classification, and supporting calculations. Studies are subject to IRS review.

When a property has mixed use, such as commercial and residential components, costs may need to be apportioned. QIP classification depends on whether improvements are made to an interior portion of a nonresidential building. If purchasing a second-hand property, understanding the previous owner’s depreciation history can be relevant for determining the remaining depreciable basis.

How to Make Your Claim

Depreciation deductions are claimed on the relevant tax return for the business or income-producing activity, such as Schedule C for sole proprietors, Form 1065 for partnerships, or Form 1120 for corporations. IRS Form 4562, “Depreciation and Amortization,” is used to report these expenses.

Depreciation is generally claimed in the accounting period when the property is placed in service, meaning it is ready for its intended use. The calculation uses the property’s depreciable basis, its recovery period (e.g., 5, 7, 15, 27.5, or 39 years), and the Modified Accelerated Cost Recovery System (MACRS). For real property, depreciation begins in the month the building is placed in service, using a mid-month convention.

Maintaining detailed records is crucial to support any depreciation claim. The IRS may request documentation, such as invoices, contracts, and cost segregation study reports, to verify deductions. Accurate record-keeping ensures compliance and can prevent issues during an audit.

When a depreciable asset is sold or disposed of, “depreciation recapture” rules apply. This means any gain realized from the sale, up to the amount of previously claimed depreciation, may be taxed as ordinary income. This rule ensures the IRS reclaims tax benefits provided.

Specific Property Use Cases

Property use impacts depreciation. Commercial properties, like office buildings, depreciate their main structure over 39 years. Residential rental properties generally depreciate over 27.5 years. Both property types can benefit from accelerated depreciation on qualifying tangible personal property and qualified improvement property through cost segregation studies.

For new builds, construction costs can be analyzed and allocated to various depreciable asset classes to maximize upfront deductions. When acquiring existing properties, the focus shifts to identifying embedded tangible personal property and qualified improvement property from the purchase price, along with any subsequent renovations. Depreciable basis excludes land value.

Businesses owning and occupying their premises can claim depreciation on qualifying assets used in their trade or business. Landlords can claim depreciation on qualifying expenditures within their rental properties, as these are held for income production.