Moving Time

Hal Lindorf is one of the partners in a three-partner firm of consulting engineers. For the last few months I have been helping him and his partners develop a strategic plan, and it isn’t unusual for him to drop into our offices in order to kick a few ideas around.

“We’ve made a big decision,” Hal grinned.

“Whatever it is, you seem pleased.”

Hal’s a big bear of a man and he leaned forward as he spoke. “We’ve decided that we need to have some excess capacity if we’re going to grow the way we want to. In fact, I’ve discovered that people in our firm have subtly been discouraging new business because they feel overworked already.”

“It sounds like you’ve made a commitment to hire extra people.”

“Exactly. That’s something we must do. But before that, we need to move to larger premises. That’s why I’m here. I want you to tell me about the rules for moving expenses.”

“Basically the company can deduct from its income any reasonable expense associated with moving.”

“That sounds easy.”

“The real issues are associated with leaseholds,” I said.

“What do you mean by leaseholds?”

“When you rent a property you have a leasehold interest in it. In most cases that leasehold is not worth anything since normally you can’t sell it for a profit, but in some cases the leasehold itself is a valuable asset. For example, one of our clients owns the remainder of a 99-year lease on an apartment in London, England. He obtained the lease in 1980, and it has about 80 years left to run. Because rents have risen dramatically in London, and because the lease does not limit his profits on a re-sale, he could now sell his leasehold interest for a tidy gain.

“Under most Canadian leases, the rent is adjusted to market rates every five years and the profits on a sublease go to the owner, not the lessee. When Canadians talk about leaseholds, they are usually referring to leasehold improvements. You can think of leasehold improvements as anything that your company spends on its rental space to make it more efficient or more attractive for work. Leasehold improvements are treated as assets for accounting purposes.”

“Would leasehold improvements include workstations? We plan to buy a few of them.”

“Leasehold improvements include immovable items only — the things you must leave behind when you depart from the space. For example, built-in cabinets and bookshelves, wall-to-wall carpet, that sort of thing. Since leasehold improvements are assets, they are depreciated and their rate of depreciation is determined by elements of your lease agreement. Movable workstations and other furniture are depreciated at 20% per year on a declining balance basis without regard to your lease arrangements.”

“So furniture is written off over five years?” Hal asked.

“Not exactly, although you might think so, based on the 20% write-off. But since the amount depreciated is always based on the declining balance, about two-thirds of the asset cost is depreciated in five years — and about 90% is depreciated in 10 years.”

“That’s not unreasonable since our furniture lasts for about 10 years. But how does the treatment of leasehold improvements compare to the write-off for furniture in general?”

“That depends on the lease,” I said. “Leasehold improvements are depreciated straight line over the number of years of the lease term and one renewal period if the lease has a renewal period.

“Hah!” Hal said. “So if you had a one year lease, you could write off your leasehold improvements in 12 months.”

“Whoa, you’re too quick. I wasn’t finished. Leaseholds can be depreciated over a minimum of five years and a maximum of 40. So you can’t write them off in less than five years. And like most assets they are subject to half depreciation in the year of acquisition. Nonetheless leasehold improvements can be written off faster than many other assets.”

“How?”

“You must arrange to have your lease term and the first renewal term add up to five years.”

“But doesn’t that make the company more vulnerable than if we were to sign a typical lease? When we sign our new lease we want to establish our rights to the property for the next 15 years. We plan to make a lease offer for an initial five year term at current rates and then two optional renewal periods at market rates.”

“Your position reflects a typical lease offer. However, to maximize your write-offs, I’d advise you to make the following proposal: an initial term of three years at current rates, a renewal period of two years that can be triggered either by you or the landlord at the same rental rates as the initial term, then second and third renewal options of five years each at rates current at the time of the renewal. Since the first renewal can be triggered by either you or the landlord, it’s very likely to be used. This offer gives you the same protection over 15 years as your contemplated offer — except that you gain a little freedom in the situation where both you and the landlord do not trigger the first renewal.”

“One final question,” Hal said. “What happens to the undepreciated balance in our leasehold account when we move? Can we write off the assets that we have abandoned?”

“Not generally. The balance continues to be depreciated under normal rules as long as you have any depreciable leaseholds. So when you move from one location to another, there is no immediate write-off of the old leasehold interest. However if you no longer have any actual leasehold assets, then the balance in the account can be written off. That might occur if you go out of business, or if you move into a building that your company owns.”

“All right,” Hal said. “I’m glad I stopped by. I’ll have our lawyer call you to vet our lease proposal. Shortening our write-off period from 10 years to five certainly makes sense.CCE

Hank T. Bulmash, C.A., MBA is a principal in Bulmash Cullemore chartered accountants of Toronto.