Leasehold Improvement

Posted on by user

Leasehold Improvements

What they are

Leasehold improvements (also called tenant improvements or build-outs) are alterations made to a rental property to customize the space for a specific tenant’s needs. Common examples include painting, new flooring, partitions or cubicles, shelving, countertops, and custom lighting or fixtures. Improvements are typically made to interior spaces and may be performed or paid for by either the landlord or the tenant.

How they work

  • Changes are tailored to a tenant’s use of the leased space and generally benefit only that tenant.
  • At lease end, improvements usually remain with the property and belong to the landlord unless the lease states otherwise. If a tenant is allowed to remove improvements, they must do so without damaging the property.
  • Not every alteration qualifies as a leasehold improvement. Exterior renovations and building-wide systems (e.g., roofs, elevators, HVAC, alarm/security systems) are treated as building improvements because they benefit multiple tenants or the whole building.

Common types of arrangements

  • Tenant Improvement Allowance (TIA): Landlord provides a budget (lump sum or per-square-foot) that the tenant controls; tenant manages the work and pays any cost overruns.
  • Rent Discount: Landlord offsets some or all renovation cost with reduced rent (e.g., a free month or temporary lower rent).
  • Building Standard Allowance (Build-Out): Landlord supplies a set package of improvements and typically manages the project. Tenants can request additional work at their expense.
  • Turnkey: Landlord oversees and pays for the build-out based on tenant-submitted plans; tenant moves into completed space.

Tax and legal rules (summary)

  • Leasehold improvements can be classified as Qualified Improvement Property (QIP) for tax purposes. Treatment has evolved with legislation:
  • PATH Act (2015) established 15-year straight-line recovery for certain leasehold improvements under specific conditions.
  • The Tax Cuts and Jobs Act (TCJA) created the QIP category and relaxed some prior restrictions, specifying improvements must be interior property.
  • Subsequent legislation (including the CARES Act) clarified that QIP is a 15-year property and eligible for accelerated first-year depreciation in applicable circumstances.
  • Improvements generally must be interior work that primarily benefits a specific tenant to qualify as leasehold/QIP.

Accounting treatment

  • Expense vs. Capitalize: Improvements are capital expenditures, not immediate tax-deductible expenses. Small items below a company’s capitalization policy may be expensed; larger projects should be capitalized.
  • Depreciation:
  • For tax purposes, QIP is typically depreciated over 15 years (as clarified by recent tax changes) and may be eligible for bonus/first-year depreciation where allowed.
  • Under U.S. GAAP, leasehold improvements are amortized over the shorter of the asset’s useful life and the remaining lease term (including reasonably assured renewal periods).
  • Who claims deductions: The party that performs or pays for the improvements generally takes the depreciation (subject to lease terms and tax rules).

Leasehold vs. Building improvements

  • Leasehold improvements: Benefit a single tenant’s leased space and are interior in scope (e.g., partitions, tenant-specific fixtures).
  • Building improvements: Benefit the entire property or multiple tenants and often change the structure or longevity of the building (e.g., new roof, parking lot, elevator, HVAC replacement).

Examples

  • Leasehold improvements: Installing built-in retail shelving, adding interior walls and offices, new carpeting/wood flooring, specialized lighting for displays, reception counters.
  • Not leasehold improvements: Replacing the building’s roof, resurfacing parking lots, installing a new elevator, or upgrading the central HVAC system.

Who pays and project risks

  • Landlords commonly provide allowances, manage projects, or discount rent to fund improvements. Tenants may oversee work and pay directly, seeking reimbursement up to an agreed amount.
  • Tenants are typically responsible for cost overruns beyond any allowance and must ensure removal of tenant-owned fixtures complies with the lease and leaves the property undamaged.
  • Lenders often will not finance improvements on terms that extend beyond the lease life.

Bottom line

Leasehold improvements customize leased space to meet a tenant’s operational needs. They are capitalized and depreciated rather than immediately deductible, with tax and accounting treatment depending on the nature of the work, who paid for it, and current tax law (notably the Qualified Improvement Property rules). Clear lease provisions governing payment, ownership at lease end, and removal rights are key to avoiding disputes.