2004 a busy year for real estate tax legislation.

Calendar year 2004 was a relatively active one for tax legislation effecting real estate. The significant items of interest represent both opportunities lost and found.

1. Sunset of "Bonus" Depreciation; Some May Realize Benefits in 2005.

To stimulate capital expenditures Congress previously enacted legislation providing for "Bonus" or accelerated depreciation for certain new asset additions and improvements made after September 11, 2001 and prior to January 1, 2005.

In order to secure the benefits of "Bonus" depreciation the related asset generally had to be placed into service prior to January 1, 2005.

However, as with many rules there is an exception. Certain property that otherwise satisfies the requirements but is placed in service after December 31, 2004 and prior to January 1, 2006 will qualify for "Bonus" depreciation.

In order to qualify for this exception the property must have a "recovery period" of at least 10 but no more than 20 years (ex. land improvements or "Qualified Leasehold Improvements") and either have an estimated production period that is greater than two years or have an estimated production period that is greater than one year and a cost in excess of $1,000,000.

Where the new property qualifies for the extended placed-in-service date, the actual amount that qualifies for the "Bonus" depreciation is limited to the costs actually incurred prior to January 1, 2005.

2. Recovery Period is Shortened for Depreciation of Certain Leasehold Improvements.

The American Jobs Creation Act of 2004, which was enacted in October, made major changes to the taxation of businesses and individuals. Several of these provisions affect the real estate industry.

One change that potentially affects a nonresidential landlord's and tenant's analysis of the after-tax cost of a proposed lease provides a faster write-off through depreciation of the cost of certain leasehold improvements.

The new legislation provides that the cost of certain leasehold improvements made by lessors, lessees or sub-lessees, are recovered over a 15-year period, using the straight line method, if they are placed in service after October 22, 2004 and before January 1, 2006. Otherwise, the improvements would be depreciated over their normal tax life, which would generally be 39 years for improvements classified as non-residential realty.

In order to qualify for 15-year depreciation, the expenditure must be for an improvement:

(a) To an interior portion of a non-residential building;

(b) That is placed in service more than three years after the date the building was first placed in service; and

(c) That is not attributable to the enlargement of the building. It also does not include the cost of any elevator or escalator, any structural component benefiting a common area, or the internal structural framework of the building.

In addition, if the lessee or sub lessee intends to claim the deduction, it must exclusively occupy the premises. Furthermore, improvements to property leased between related persons do not qualify.

As a planning note, when one analyzes the effective dates of the sunset of the "Bonus" depreciation provisions and of the 2004 legislation, it is possible that if the timing is "right," the costs of certain "leasehold improvements" may benefit from both; that is 50% "Bonus" depreciation for costs incurred as of December 31, 2004 and 15-year depreciation for the remaining basis after "Bonus" depreciation.

As an additional planning note, landlords and tenants should consider whether enhanced depreciation benefits might be realized through a cost segregation study to isolate the cost of assets that may be depreciated over even shorter tax "lives."

Under the new legislation leasehold improvements to restaurant property are treated more liberally and qualify for 15-year amortization as long as they are placed in service more than three years after the date the building was first placed in service.

For this purpose a building qualifies as a restaurant if more than 50 percent of the building's square footage is devoted to the preparation of, and seating for, on-premises consumption of prepared meals.

3. Additional Deduction for Certain Construction Activity.

The new legislation also provides an additional deduction for the 2005 tax year and thereafter for taxpayers who perform construction in the United States.

The additional deduction is also available for taxpayers performing engineering or architectural services in the US for US-based construction projects. For this purpose, "construction" includes activities that are directly related to the erection or substantial renovation of residential and commercial buildings and infrastructure. Substantial renovation includes structural improvements, but not mere cosmetic changes, such as painting.

Initially, the deduction is equal to 3% of the taxable income from construction or the performance of architectural or engineering services. The deduction increases to 6% for taxable years beginning in 2007, 2008 and 2009, and 9% thereafter. However, the deduction is limited to 50% of the annual W-2 wages paid by the taxpayer.

Therefore, to potentially maximize the benefit of this deduction a contractor may consider in appropriate circumstances hiring additional employees rather than engaging independent contractors.

As an additional limitation, the deduction may not exceed taxable income determined without regard to this deduction (or adjusted gross income, as specifically defined, for an individual).

There are further potential technical complications where the construction activity is carried on by pass-through entities, such as partnerships, limited liability companies or "S" corporations.

Further clarification or restrictions of the rules regarding pass-thru entities will await IRS regulations.

WAYNE OLSON,

PARTNER,

MARGOLIN, WINER & EVENS LLP