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Get your landlord to fix things up
Your "construction allowance" is considered taxable income unless you follow these rules.
Here's a typical scenario for many veterinarians: You're entering new rental space, and you've negotiated with your landlord to have him finance the fix-up costs by providing funds for you to make the improvements. These funds are commonly called a "construction allowance" and can either be advanced to you directly or come out of your rent payments. Under IRS guidelines, this allowance is considered taxable income—unless you follow these rules:
Gary I. Glassman
Your lease must be for commercial real estate, and the term can't be for more than 15 years, including renewal options. In addition, you and your landlord must sign an agreement specifically stating that the construction allowance is intended to improve or build the hospital, and you must sign the agreement before the construction allowance is paid.
To qualify, the construction allowance must be used to build or improve commercial property within a retail "space." You must use this space as part of your practice. And it can include areas where other practice-supporting activities take place, such as office space, storage areas, or employee lounges.
You don't have to trace your use of the construction allowance funds to the actual costs, but you should keep good records of the amounts you received and the payments you made for improvements or construction. You must spend the allowance within 8½ months after the end of the year in which you received the money. If you spend your own money, the construction allowance can be paid as a reimbursement for costs you paid in an earlier year and is not subject to a time limit. The only requirement for the reimbursement is that you as the tenant can't claim depreciation deductions for the property for which you're asking for reimbursement.
By IRS definition, the construction allowance is considered a "safe harbor," which means that if you follow the rules you're assured favored tax treatment. But it also means that it's especially important to follow all the rules to the letter. For this reason, you may want to have any construction allowance agreement you're considering reviewed by your tax advisor and attorney before you sign it.
Gary I. Glassman, CPA, is a partner with Burzenski and Co. PC in East Haven, Conn., and a Veterinary Economics Editorial Advisory Board member.
