RRA changes affect leases.

Two significant changes in the Revenue Reconciliation Act of 1993 (RRA) have an impact on the leasing of real estatc. The first change extends the recovery life of commercial real estate from 31.5 years to 39 years. This change may affect lease negotiations by further decreasing the desire of tenants to take payments from landlords for tenant improvements instead of rent abatements. Normally, landlords and tenants have different preferences as to lease incentives, with landlords first preferring free rent, second, allowances and third, improvements, while tenants prefer first, improvements, second, free rent and third, allowances.

Because of the extended life of certain improvements, the "tax penalty" for owning these improvements has increased. The increase in rccovery period also reinforces the need to identify who owns any tenant 1mprovements in the leasc document. The allocation of improvements between Sec. 1245 property, which may have a seven-year life, and Sec. 1250 property, which, as noted, has a new 39-year life, is important to the party who takes title to the improvements. Hence, the necessity to perform a thorough cost segregation study is apparent.

The second change has an impact on the recovery period of premiums paid on the acquisition of property attributable to favorable leases. Under prior law, the amount of premium paid on the purchase of property was amortized over the term of the related "above market" leases. This normally accelerated the deduction of acquisition costs. Under the RRA, any premium paid must be added to the basis of the acquired property and not the lease period. Further, the allocation of a premium between depreciable property and nondepreciable land will warrant a more careful review.

It should be noted that lessees who acquire a beneficial lease interest still fall under old law, which allows the premium to be amortized over the remaining lease term.

In conclusion, landlords and tenants should be aware of reductions in depreciation deductions attributable to some tenant improvements. Buyers of property should be aware of the extended recovery period of premium purchase payments made because of the existence of high rents.

From John O'Connor, CPA, Los Angeles, Cal.