Open a commercial fixed asset schedule and look for the line that reads "leasehold improvements, 39 years." On a $600,000 tenant buildout, that single line costs roughly $190,000 of first-year tax deferral, because it buries carpet, millwork, dedicated power, and data cabling inside the longest recovery period the code offers.
A renovation is a placed-in-service event in its own right. It carries its own date, its own invoices, and its own classification question, and none of that was answered by whatever was done when the building was bought.
Key takeaways
- Every renovation is a new depreciation event. Cost segregation on tenant improvements is repeatable, not a once-per-building exercise.
- Every renovation dollar faces a three-way decision: deductible repair, 15-year qualified improvement property, or 5-year §1245 personal property.
- A single "leasehold improvements" line is the most expensive line on most fixed asset schedules, because it buries 5-year property inside a 39-year class.
- When a renovation replaces something, a partial asset disposition election writes off the remaining basis of what was removed — a second deduction most owners never claim.
- §179 reaches nonresidential roofs, HVAC, fire protection, and security systems that bonus depreciation cannot.
The Three-Way Decision Every Renovation Dollar Faces
Before any depreciation question, ask whether the work is capitalized at all. Under Treas. Reg. §1.263(a)-3, an expenditure is capitalized only if it is a Betterment, an Adaptation to a new or different use, or a Restoration. Repainting a suite is a repair. Converting storage to a lab is an adaptation. The repair versus improvement framework walks the tests and the safe harbors.
If the dollar is capitalized, it lands in one of three places:
§1245 personal property (5-year, sometimes 7-year). Carpet and removable flooring, decorative lighting, millwork and cabinetry, dedicated electrical for equipment, data cabling, window treatments, security and communication equipment, appliances, certain specialty plumbing. Recovered on 200% declining balance and bonus-eligible.
Qualified improvement property (15-year, straight-line, bonus-eligible). Interior improvements to a nonresidential building placed in service after that building was first placed in service, excluding enlargement, elevators and escalators, and internal structural framework. Drywall, ceilings, general lighting, HVAC distribution, and general plumbing usually land here. Note the word nonresidential: apartment interiors get no QIP. See the QIP guide.
39-year building. Structural framing, enlargement, and anything the first two exclude.
Line by Line: A $600,000 Office Tenant Buildout
Example: a 12,000 square foot office buildout, nonresidential building originally placed in service 2011, buildout completed May 2026 Total capitalized cost $600,000 including $22,000 of architecture, engineering, and permit fees allocated proportionally across classes.
| Scope item | Cost | Classification |
|---|---|---|
| Demolition of existing partitions and ceilings | $24,000 | QIP, 15-year |
| Framing, drywall, doors, paint | $82,000 | QIP, 15-year |
| Acoustical ceiling grid and tile | $30,000 | QIP, 15-year |
| Carpet tile and removable luxury vinyl plank | $46,000 | 5-year §1245 |
| Ceramic tile, restroom floors and walls | $12,000 | QIP, 15-year |
| Millwork, reception desk, break room cabinetry | $53,000 | 5-year §1245 |
| Decorative and accent lighting | $16,000 | 5-year §1245 |
| General lighting and branch power distribution | $58,000 | QIP, 15-year |
| Dedicated circuits for equipment and server room | $27,000 | 5-year §1245 |
| Data and communication cabling | $34,000 | 5-year §1245 |
| HVAC distribution: ductwork, VAV boxes, diffusers | $68,000 | QIP, 15-year |
| Supplemental cooling unit dedicated to server room | $23,000 | 5-year §1245, load calc required |
| Plumbing, general restroom core | $16,000 | QIP, 15-year |
| Plumbing, break room equipment rough-in | $8,000 | 5-year §1245 |
| Exterior tenant signage | $9,000 | 15-year land improvement |
| Window treatments and blinds | $12,000 | 5-year §1245 |
| Security and access control system | $18,000 | 5-year §1245 |
| New interior stair and structural framing | $42,000 | 39-year building |
| Architecture, engineering, permits | $22,000 | Allocated proportionally |
| Total | $600,000 |
Rolled up and with soft costs allocated:
| Class | Basis | Year-one deduction |
|---|---|---|
| 5-year §1245 personal property | $246,000 | $246,000 (100% bonus) |
| 15-year land improvements | $9,300 | $9,300 (100% bonus) |
| 15-year QIP | $301,000 | $301,000 (100% bonus) |
| 39-year building | $43,700 | $700 |
| Total | $600,000 | $557,000 |
Booked as a single 39-year "leasehold improvements" line, the same $600,000 produces about $9,600 of first-year depreciation, applying the mid-month convention to a May completion. The incremental difference is roughly $547,400 of deduction, or about $191,600 of cash at a combined 35% rate. The gating question is not the classification but §469: an owner with no passive income and no material participation banks a suspended loss, not $191,600 of cash.
Two lines deserve a note. The supplemental cooling unit is what an examiner will question: where it serves server equipment rather than occupant comfort, §1245 treatment is supportable, but it needs a load calculation behind it, not a label. And furniture and workstations, deliberately absent above, are usually bought outside the construction contract and land on a separate 7-year schedule. Reconcile them so they are neither missed nor double-counted.
Where §179 Reaches What Bonus Cannot
Bonus depreciation covers property with a recovery period of 20 years or less, plus QIP. It does not reach the 39-year building. §179(f) does, for a short and useful list: roofs, HVAC, fire protection and alarm systems, and security systems on nonresidential real property.
For tax years beginning in 2026 the §179 maximum is $2,560,000, phasing out dollar for dollar from $4,090,000 of qualifying property placed in service to $6,650,000. The catch: §179 is limited to business taxable income and cannot create a loss, with disallowed amounts carrying forward. On a renovation that includes a new rooftop unit or a fire alarm replacement, it is often the only tool that reaches those dollars. Compare the two in §179 versus bonus depreciation.
The Second Deduction: Write Off What You Tore Out
Look at the first line of the buildout table: $24,000 of demolition. Something was demolished, and that something has remaining basis sitting inside the building's schedule from the 2011 buildout.
Under Treas. Reg. §1.168(i)-8 you may elect a partial asset disposition to recognize a loss on the remaining adjusted basis of the replaced component. Three things happen at once. You take an ordinary loss now. You stop depreciating an asset that no longer exists. And you remove that basis from the building, reducing future §1250 recapture on sale.
The election is annual, made on a timely filed return including extensions, and generally irrevocable. Miss the year and the opportunity is generally gone, which is why it has to be caught during the renovation rather than in a cleanup project three years later. The partial asset disposition election covers the mechanics and the basis computation methods. Treat every renovation as two exercises: classify what went in, and dispose of what came out.
When Classifying a Renovation Isn't Worth It
If the work is already fully deductible, capitalizing it into a study is a downgrade. The de minimis safe harbor covers items at $2,500 per invoice or item without an applicable financial statement, $5,000 with one, and routine maintenance covers recurring work. A repair deducted at 100% today beats QIP at 100% today, decisively so if bonus is ever unavailable to you. Run the RABI test first.
Small individual projects don't justify a standalone engagement. A $40,000 suite refresh does not warrant its own study fee. Batch a year of capital work into one annual engagement.
Confirm who owns the improvements. If the tenant pays for and owns the buildout, the landlord has no basis to depreciate. A landlord-paid TI allowance generally does create landlord basis, but the lease governs and has to be read before the fixed asset entry is made.
Residential rental gets no QIP. Apartment interior work sorts into 5-year §1245 property, repairs, and 27.5-year building. Still a real strategy, but pricing a study on a 15-year bucket that does not exist produces a disappointed client.
Frequently Asked Questions
Do I need a new study for every renovation?
Not a new full study. You need classification of the new spend, best handled by an active owner as an annual engagement covering that year's additions rather than project by project.
What if past renovations were already booked to 39 years?
Once a method has been used on two consecutively filed returns it is an accounting method, correctable by Form 3115 with a §481(a) catch-up taken entirely in the year of change. If only one return has been filed, amend instead. Note that this recovers missed depreciation but does not resurrect a missed partial disposition election.
Does this apply to retail and restaurant spaces too?
Yes, usually with better results, because those buildouts carry heavy decorative finishes, specialty lighting, and dedicated equipment power. See cost segregation for retail properties.
Is demolition cost deductible?
Generally no when it is part of a capital improvement project. Demolition costs are typically capitalized into the improvement they enable. The separate deduction comes from electing a partial disposition on the removed component's remaining basis.
See What Your Property Would Yield
Every building is different, and the only way to know your number is to look at your building. Precision Cost Segregation provides a no-cost feasibility analysis: send us the property address, purchase price, closing date, and any improvements, and we'll model your likely reclassification and first-year benefit before you commit to anything.
Request a free feasibility analysis →
This article is provided by Precision Cost Segregation for general educational purposes and does not constitute tax, legal, or accounting advice. Tax outcomes depend on your specific facts, your tax rate, your passive activity position, and your entity structure. Figures shown are illustrative. Consult your CPA or tax advisor before acting, and engage a qualified professional to perform any cost segregation study. Information is current as of publication.
This article is general information, not tax or legal advice. Depreciation outcomes depend on your facts, elections, and current law — consult your CPA before acting. © 2026 Precision Cost Segregation.