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IRS Excludes Exterior HVAC Units from Special Depreciation Treatment



In a Chief Counsel Advice (CCA) Memorandum, the IRS concluded that heating, ventilation and air conditioning (HVAC) units installed outside of a building or on its roof are not eligible to be treated as qualified leasehold improvement property (QLIP) for special depreciation purposes.

Suggested Action:

Contact a CohnReznick tax professional to determine how this ruling will impact your tax position.


Per the CCA memorandum, a taxpayer leasing a commercial building used for retail sales bore responsibility under the lease for improvements to the space. The lessee replaced several HVAC units located on the roof of the building or on a concrete pad next to the building. The HVAC units served the leased space, which was exclusively occupied by the taxpayer.

The CCA’s office questioned whether the HVAC units met the requirements to be considered as QLIP. QLIP is defined as any improvement to an interior portion of a building that is nonresidential real property and that meets the following requirements:

  • Improvement is made by either the lessor or the lessee, under or pursuant to a lease of the interior portion
  • The interior portion is to be exclusively occupied by the lessee or a sub-lessee
  • The improvement is placed in service more than three years after the date the building was first placed in service


Property that receives QLIP treatment can be depreciated over fifteen years using the straight-line method. Under general depreciation rules, nonresidential real property is depreciated over 39 years. Additionally, QLIP is eligible for bonus depreciation.

In making the determination that the HVAC units in question are not QLIP, the CCA memorandum focused on the “interior portion” language in the QLIP definition. The CCA concludes that because the definition uses the word “interior,” the improvements must be made to the inside of the tenant’s space in order to qualify. HVAC units on the roof or on slabs outside the building, then, cannot be QLIP.

Our View of the News
The CCA memorandum focuses only on the cost of the HVAC system located outside the tenant’s leased space. Typically, 50 percent or more of the cost of an HVAC system is located inside the tenant’s space, in the form of ductwork, electrical connections, thermostats and other internal components. A cost segregation study can determine the breakout of costs between external and internal HVAC components.

For more information, please visit our Tax Specialty Services webpage.

Circular 230 Notice: In compliance with U.S. Treasury Regulations, the information included herein (or in any attachment) is not intended or written to be used, and it cannot be used, by any taxpayer for the purpose of i) avoiding penalties the IRS and others may impose on the taxpayer or ii) promoting, marketing, or recommending to another party any tax related matters.

This has been prepared for information purposes and general guidance only and does not constitute professional advice. You should not act upon the information contained in this publication without obtaining specific professional advice. No representation or warranty (express or implied) is made as to the accuracy or completeness of the information contained in this publication, and CohnReznick LLP, its members, employees and agents accept no liability, and disclaim all responsibility, for the consequences of you or anyone else acting, or refraining to act, in reliance on the information contained in this publication or for any decision based on it.

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