Nonresidential Property and the 39 Year Class

Nonresidential real property is generally depreciated over 39 years, a longer period than residential rental property. Because the default schedule is slow, owners of commercial buildings frequently consider whether a study could accelerate depreciation on the parts of the building that qualify.

What falls in the class

In general terms, nonresidential real property covers buildings that are not residential rental property and not property with a shorter assigned life. Common examples are office buildings, retail centers, warehouses, industrial buildings, medical offices, and restaurants housed in buildings. Buildings that fail the 80 percent dwelling unit test can also land here. Hotels and similar lodging are treated as nonresidential in general because units are used on a transient basis.

Mechanics

The straight line method is used over 39 years with the mid-month convention. The annual deduction in a full year is a little over two and a half percent of the building basis. Land is excluded.

A comparison with a study

Without a study, the entire depreciable basis of the building is generally on this slow schedule. With a study, components with shorter lives are separated. Because commercial buildings often include specialized systems, tenant improvements, and site work, owners often see more categories to analyze than in a plain residential building. Whether that yields a meaningful shift depends on the building.

Tenant improvements

Improvements made for tenants can have their own classification, including qualified improvement property for certain interior improvements to nonresidential buildings with a 15 year life. Landlord and tenant treatment can differ. If you are a landlord who paid for improvements, or a tenant who did, ask your preparer about the classification. See How Bonus Depreciation and Cost Segregation Interact.

Specialized components

A study might identify items that serve the specific operation of a tenant's business, such as special electrical or plumbing for equipment, or certain finishes, as distinct from general building systems. Classification depends on the facts and on case law. See Examples of 5 and 7 Year Property in Rentals and Commercial Buildings.

Site work

Parking lots, sidewalks, landscaping, signage, and drainage can be significant in commercial properties. These are typically land improvements with a 15 year class. See Land Improvements and the 15 Year Class.

Usability

Owners of commercial property often hold it in entities. The deduction may pass to owners who have passive income or who otherwise can use it. Rental of commercial property is generally treated as a rental activity, so passive rules often apply. See The Passive Activity Loss Rules and Cost Segregation.

Triple net and operating businesses

If you own the building and operate a business in it, the treatment differs from owning a building leased to an unrelated tenant. Ownership structure matters for passive and participation analysis. See Material Participation Tests in Plain Language.

Sale considerations

Commercial buildings are often held for longer periods, and are sold or exchanged. See Depreciation Recapture on Sale: What Comes Back and Section 1031 Exchanges and Depreciation Recapture.

Small commercial properties

Small commercial properties may have less to reclassify, or a modest total basis. Scale matters. See Small and Low-Basis Properties.

What to ask

• What share of the building is nonresidential rental?
• Are there tenant improvements I paid for?
• Which site improvements exist?
• Are the deductions usable?

Illustrative cases in words

A small medical office building leased to a group practice, with specialized plumbing and electrical for treatment rooms, may have items that serve the medical operation rather than the general building. A retail strip center with a large parking lot may have substantial site improvements. A warehouse with minimal finishes may have less to reclassify, but may have loading docks, lighting, and paving. A restaurant building may include specialized ventilation, plumbing, and finishes. Each case illustrates why classification depends on the property and not just the type.

Considerations for lease structure

If the tenant paid for and owns certain improvements under the lease, they may not be your assets. If the landlord paid for the improvements, they belong on the landlord's schedule. Review the lease for provisions about ownership of improvements at lease end. The study should reflect who owns what.

Timing of placing in service

Commercial buildings may be placed in service in phases as tenants take possession. Each phase may have its own placed-in-service date for the improvements. Keep records of when each portion was ready for use.

Recordkeeping

Keep leases, tenant improvement allowances and invoices, certificates of occupancy, and rent rolls.

Questions to ask about your building

Is any part of the building used for something other than the main use, such as an apartment above a shop? Which improvements were made by tenants and which by you? Which site features exist? Are there specialized systems that serve a tenant's process? When was each portion placed in service? Answers shape the study scope and the classification.

Compare to residential

Nonresidential buildings depreciate more slowly on the default schedule, so the theoretical gap between the default and accelerated treatment is wider than for residential property. That is often given as a reason for owners of commercial property to look closely. The gap is only one factor, and usability and hold period still decide the outcome.

Next steps

Read Commercial Properties: The Study Decision for a decision-focused view and Depreciation Classes: 5, 7, 15, 27.5, and 39 Years for the whole picture.