Expert: Arthur Naman - 11/16/2011

Question
Hi
I work for an S-Corp where the owner is buying a building (he is setting up an LLC for that) and he will be leasing the S-Corp the space.  What I am wondering is how do you distinguish what items the S-Corp can call leasehold improvements and what improvements the LLC will have to depreciate with the building itself.  Right now the building has an office space ready to go but the manufacturing area needs heating and air conditioning...which the owner is going to pay for through the LLC.  Basic needs (like bathrooms, heating/air etc.) seem like they should be depreciated with the buildling...but items like special lighting and flooring required by the S-Corp business should be something the S-Corp can run through leasehold improvements.  These are things the S-Corp would have had to improve if they were leasing any new space.  Any guidance in this area would be appreciated, Thanks

Answer
The answer is not clear because normally there would be an agreement as to what
improvements are to be paid be the building improvements are to be paid by the
building ownet and which are to be paid by the lessee. That is apparently not
the case here.

Keep in mind that at the end of the lease any improvements will be owned by the
building owner, not the lessee.

You are in a position where your boss is telling you that the lessee will be
paying what should be expenditures of the building owner, accordingly your
reasoning appears ok to me. Any improvements required for the corp's specific
purposes, special floors for example should probably be treated as leasehold
improvements. Things like general heating or air conditioning can then be
depreciated as building improvements.

I would encourage you to discuss this with whoever will be preparing the annual
tax returns. Their input as to how to treat specific expenditures is key.

Please ask a follow-up if thid is not clear.