🇺🇸 Made in America·100% U.S.-Based Team · 24+ Years in Cost Segregation
In a small office above a coffee roastery in Portland, Oregon, last September, a commercial landlord named Brian was reviewing a Letter of Intent from a prospective tenant. The tenant was a regional law firm. They wanted 8,400 square feet on the second floor of his Class B office building. The deal terms were close to closed except for one number.
The number was $420,000. That was the cost of the tenant improvements the law firm wanted: new partition walls, dropped ceilings, dedicated electrical for IT and conference rooms, new flooring throughout, three glass-wall conference rooms, a small kitchen, and updated bathroom finishes. The law firm wanted Brian to pay for the improvements as part of the lease deal. Brian's broker had told him this was standard for an anchor commercial tenant of this size.
Brian's accountant had told him something else. The $420,000 would be capitalized as an improvement to the building and depreciated over 39 years. Year 1 depreciation: about $10,800. Useless against current-year tax pressure.
Brian looked at the number and saw a problem he was about to walk into. He needed to spend $420,000 of capital in October to land an anchor lease that produced approximately $1.4 million of rent over its life. The lease made sense. The capital lockup did not.
His broker did not have a solution. His accountant did not have a solution. The deal sat for a week.
It turned out there was a solution his accountant had not raised. The solution was cost segregation combined with the Qualified Improvement Property rules. Properly applied, the $420,000 of tenant improvements could produce roughly $300,000 to $360,000 of Year 1 deductions instead of the $10,800 his accountant had projected. At a 37 percent marginal federal bracket, the immediate tax savings ran to approximately $110,000 to $133,000. Cash recovered in the same tax year the capital went out.
This is the tax advantage commercial landlords get when tenant improvements are properly classified. This article walks through how Qualified Improvement Property works, what tenant improvement components qualify for shorter recovery periods under cost segregation, and how landlords routinely recover 25 percent to 35 percent of TI capital in Year 1 federal tax savings.
Qualified Improvement Property (QIP) is a specific category of building improvements created by the Tax Cuts and Jobs Act of 2017 and refined by the CARES Act of 2020.
The technical definition: QIP is any improvement to the interior portion of a non-residential building, placed in service after the building itself was first placed in service. Certain components are excluded from QIP treatment, including enlargements of the building, elevators, escalators, and the internal structural framework. Everything else that improves the interior qualifies.
What QIP designation actually means for taxation: the property is assigned a 15-year MACRS recovery period instead of the 39-year period that applies to nonresidential real estate generally. MACRS is the IRS depreciation framework, short for Modified Accelerated Cost Recovery System. It assigns recovery periods of 5, 15, 27.5, or 39 years to different types of property. A 15-year period produces much larger annual deductions than a 39-year period. Fifteen-year property also qualifies for 100 percent bonus depreciation under the One Big Beautiful Bill Act, which restored 100 percent bonus depreciation permanently for property placed in service after January 19, 2025.
Translation: tenant improvements that qualify as QIP can be deducted in full in Year 1 instead of stretched over 39 years.
The legislative history matters here. The original TCJA bill in 2017 contained a drafting error that inadvertently excluded QIP from the bonus depreciation rules. For two and a half years, QIP was technically 39-year property because of a clerical mistake in the legislation. The CARES Act in 2020 fixed the drafting error retroactively. Property owners who placed QIP in service from 2018 through 2020 could amend prior returns or file Form 3115 to claim the benefits that were always intended.
The current rules are clean. QIP placed in service after January 19, 2025, is 15-year property that qualifies for 100 percent bonus depreciation.
Cost segregation goes further than QIP categorization. Within the QIP itself, certain components qualify for even shorter recovery periods than 15 years.
A qualified engineer performing a cost segregation study on tenant improvements separates the components into their proper MACRS classes. Some components may qualify as 5-year personal property when properly documented under the Whiteco 6-factor test (from Whiteco Industries v. Commissioner, 65 T.C. 664, 1975). The classification of any specific component depends on the facts and circumstances of the property and is determined through the engineering analysis.
Other components may qualify as 15-year Qualified Improvement Property when they meet the QIP definition under IRC Section 168(e)(6): an improvement made to the interior portion of a nonresidential building, placed in service after the building was first placed in service. QIP excludes enlargements of the building, elevators and escalators, and the internal structural framework.
A smaller portion of most tenant improvement projects stays at the building's recovery period (39 years for nonresidential, 27.5 years for residential rental). This typically includes structural changes, modifications to load-bearing elements, and components that integrate permanently into the building's primary structural or utility systems.
An engineering analysis on a typical tenant improvement project of this scope produces a breakdown that varies by the specific configuration and complexity of the work. As a general range for a fitout combining standard build-out work with some specialty business components, 5-year personal property typically runs roughly 20 to 30 percent of the total when the fitout includes meaningful specialty components, 15-year QIP roughly 60 to 75 percent of the total, and 39-year permanent improvements roughly 10 to 20 percent of the total.
These ranges are not guarantees. The actual breakdown on any specific project depends on the design, the components installed, and the engineering analysis. A heavily specialty fitout (restaurant, medical, manufacturing) shifts more toward the 5-year category. A standard office buildout sits closer to the QIP-heavy end of the range.
Under 100 percent bonus depreciation, both the 5-year and 15-year components deduct fully in Year 1. The 39-year portion continues over 39 years.
Total Year 1 deduction on Brian's $420,000 project, at the midpoints of the ranges above: approximately $340,000. At a 37 percent marginal federal bracket: $125,800 in actual federal tax savings.
Compared to his accountant's projection of $10,800 of Year 1 depreciation and approximately $4,000 of federal tax savings.
The difference is more than $120,000 of cash kept in Year 1.
The tax treatment of tenant improvements depends on who pays for them. There are three common structures:
Landlord-paid TIs. The landlord pays the TI cost directly. The improvements are owned by the landlord and capitalized on the landlord's tax return. The landlord depreciates them. This is the most common arrangement on Class A and Class B commercial properties. Cost segregation applies. QIP rules apply. 100 percent bonus depreciation applies.
Tenant-paid TIs with no reimbursement. The tenant pays for the improvements directly and depreciates them on the tenant's tax return. The tenant claims the deductions. At lease end, what happens to the improvements depends on the lease terms. Cost segregation can still apply at the tenant level.
Tenant Improvement Allowance (TIA). The landlord pays the tenant a defined dollar amount as a TI allowance, and the tenant uses that to fund the improvements. The tenant manages the construction. The tax treatment depends on whether the improvements are owned by the landlord at lease end and on the specific accounting under Section 110 of the tax code. Section 110 has specific rules for retail tenants on short-term leases that can affect treatment. In most cases, the landlord owns the improvements and depreciates them after the lease ends or earlier depending on the lease terms.
The accounting for who owns the improvements and who depreciates them is a CPA-level question that needs to be answered before the lease is signed. The cost segregation strategy is most powerful when the landlord owns the improvements and bears the cost. That is the scenario Brian was facing.
Tenant improvement projects come in many sizes. The math scales.
A $100,000 office buildout. With typical breakouts (20 percent 5-year, 65 percent 15-year QIP, 15 percent 39-year), Year 1 deduction under 100 percent bonus depreciation is approximately $85,000. Federal tax savings at 37 percent: $31,450.
A $250,000 medical office fitout. Higher density of specialty components pushes the 5-year category higher. Year 1 deduction: approximately $215,000. Federal tax savings at 37 percent: $79,550.
A $500,000 restaurant buildout. Restaurants have very high reclassification rates because of dedicated kitchen electrical, dedicated plumbing, and specialty interior finishes. Year 1 deduction: approximately $440,000. Federal tax savings at 37 percent: $162,800.
A $1,000,000 retail anchor tenant fitout. Year 1 deduction: approximately $850,000. Federal tax savings at 37 percent: $314,500.
A $2,500,000 manufacturing tenant fitout. Industrial fitouts have substantial dedicated electrical and process equipment installations. Year 1 deduction: approximately $2,200,000. Federal tax savings at 37 percent: $814,000.
These projections assume the tenant improvements qualify for QIP treatment, that 100 percent bonus depreciation applies (property placed in service after January 19, 2025), and that the property owner has sufficient taxable income to claim the deductions in Year 1.
If you are a commercial landlord paying for tenant improvements, you are sitting on one of the most powerful Year 1 deductions in the tax code. The math is favorable. The legal foundation is settled. The procedure is routine for cost segregation firms with proper engineering capability.
The default treatment by most CPAs and tax software puts tenant improvements on a 39-year schedule, producing trickle deductions year after year. The proper treatment, with QIP categorization and cost segregation classification of the personal property components within the QIP, accelerates the deductions into Year 1 where they belong.
The deductions are not aggressive. They are not a loophole. They are the proper application of MACRS class lives and QIP rules that Congress and the Treasury Department put in place specifically for commercial building improvements.
The Cost Seg America team has been performing engineered cost segregation studies on tenant improvement projects for more than 24 years. 16,000 studies. 125 IRS audits defended. Zero losses. $0 ever returned to the IRS. The average first-year savings across the 16,000+ completed studies is $438,511. Every study uses IRS Approaches 1 and 2. Every study is engineered, not estimated. Flat fee pricing disclosed before any work begins. 100 percent U.S.-based team. Unlimited audit defense included on every study. Written responses and phone representation. No time limit. No hour cap. No additional fee. Ever. Made in America, by Americans.
The next step on your project takes 30 seconds. Send the property address, the approximate TI project cost, the approximate completion date, and any drawings or scope documents you have. The Cost Seg America team sends back a free preliminary proposal within 24 hours showing the estimated Year 1 deduction, the methodology, the timeline, and the flat fee. No obligation either way.
Email: info@costsegamerica.com
Phone: 1-888-365-5023
Online: costsegamerica.com/free-proposal
Use the calculator, see your number, and request your free, no-cost proposal - delivered in 24 hours, with your flat fee quoted upfront and no obligation.