This type of situation can open a can of worms-------ie unnecessary costs------- if not handled appropriately in the frontend...............and I fully understand that many times the events are not known at the frontend---------which is the reason for the technical tax term "damage control"!

I am assuming the tenant is Sch F.........ie not incorporated.............which brings into play the self employement taxes...............and I am assuming the cost is significant enough that one needs to "manage" the taxation.

A.     Tenant pays costs...........and begins to depreciate tiling as leasehold improvement.

Then landlord says----------I'm feeling badly about this, so even though it is now a year later, I am going to start paying you some of this tiling cost back...........but there is no definite, assured payback....ie no agreement for sure, for sure.

The tenant declared the tiling to be the landlord's property by calling it a leasehold, and that is the accurate description...........since the landlord owns the tiling the moment it hit the dirt and was covered, but the tenant retained the economic interest in the USE of the tile.

Therefore..............MOST LIKELY, the IRS would holler rent reimbursement...........reducing rent expense, and increasing the annual income taxes on that amount, resulting in the self employment taxes.

Tenant does, however, retain the tiling cost as a deduction----------thru 179 or over the est life..........and that of course reduces SE taxes..................so...........other than a timing problem, the dollars will wash.

B.       Tenant pays costs...........and begins to depreciate tiling as leasehold improvement.

Landlord says I will DEFINITELY pay all the costs of the tiling, but it is going to be over a number of years.

Tenant can take position that he did the tiling on behalf of the landlord, file amended return, kill the original deduction for any depr or 179 expensing, and then NOT recognize the landlord's payments as taxable events--------merely as repayment of debt owed to tenant by landlord.

Problem--- Hassle.........have to keep track of payments, and make sure all are paid, otherwise have bad debt writeoff eventually, etc etc.

Saves the SE tax potential................but remember that any depr/179 deduction would have saved  SE taxes at front end.......................so...............dollars wash.    

Not a favorite from my perspective...............ongoing hassle.

C.       Tenant pays costs...........and begins to depreciate tiling as leasehold improvement.

Landlord says I will DEFINITELY pay all the costs of the tiling, but it is going to be over a number of years.

Tenant can take position that he sold the tiling IMPROVEMENT on the installment method........ie sales proceeds payable to tenant over period of years.

Problem..........object of sale would be deemed to be section 1245 recapture for any depr taken up to point of sale recognition.............and that means recognition of the entire recapture amount in that year.....

But..............the sale would be outside the SE tax situation....................so, tenant would have gotten the deduction against SE taxes when depr/expensed...........but not recognized SE tax upon recapture---------just like when a piece of machinery is sold.

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What to do.........................just depends.

Depends on the probability of landlord paying, what tenant's return is LIKELY going to look like over the next x years.........etc etc.

The installment sale is attractive..............merely because the income taxes zero out, assuming no change in brackets....................but there is a slice on the SE taxes.

If I were the IRS, I of course would want to take the position that the "sale" was contrived, and essentially agreed-upon before the taxation of the event..................so...............just depends on the circumstances.

Example-------If the landlord came over with the money a couple of years hence, feeling guilty or whatever...........that's good position for a sale, since it was not an "event", ie established situation, in the year of tiling transaction, so an amended return is really not the most reflective of the transaction as it originally occured.

 That kind of situation is one that I would document.............memo in the file about the discussions with the landlord, when, circumstances, age of landlord, anything at all that would describe the situation.

Every preparer has their own attitudes about these types of situations---------but we "demand" that we receive copies of such things, for two reasons---------------- to show that we are taking a reasonable position so that we cannot be held liable by the IRS or the client later when memories fade, and secondly so that we know that the document is in our files ALSO, just so there is no gap in the trail if the IRS does come around much later, and Sammy and Lulu Belle split, and she destroyed all of his possessions including tax workingpapers........etc.

Edit

Effect on the landlord------------ If a cash landlord.............only gets benefit if the transaction is treated as reduction of rent......he would then get a reduced rental income for his rent income sch.

If he is NOT cash, ie active participation...............then he would acquire tax interest in tiling and get depr/179.

He would still get the sales value that the tiling would provide when he sells the land................since he owns the tiling when installed.    He may or may not have any "basis" related to the tiling, so his "sales profit" might be a little taller..........but he would still get the cash.