What Is a Leasehold Improvement?
I'm going to break this down for you directly: a leasehold improvement is any change you make to a rental property to customize it for a specific tenant's needs. Think painting, installing partitions, updating flooring, or adding custom light fixtures. These can be handled by the landlord or the tenant, and often the tenant foots the bill. Remember, not everything counts—things like building enlargements, elevators, roofs, fire systems, alarms, security, or HVAC don't qualify as leasehold improvements.
How Leasehold Improvements Work
You might hear them called tenant improvements or build-outs, and they're common in commercial spaces where landlords make these changes for existing or new tenants to make the space more appealing. Once the lease ends, these improvements usually stay with the landlord unless your agreement says otherwise. If you're the tenant and can take them, you have to remove them without damaging the property. To qualify, changes must be interior ones that fit your specific needs, like structural tweaks, new drywall, flooring, lighting updates, electrical or tech upgrades, adding rooms or partitions, or installing shelving and countertops. But modifications for one tenant don't count for others, and exterior work like landscaping or roofing is out, as are upgrades to shared systems like elevators or HVAC.
Special Considerations
When it comes to depreciation, it depends on your accounting method. Under the IRC, you can depreciate these over 15 years if they're made per the lease terms, more than three years after the building's in service, and don't enlarge the building or add elevators or change the interior framework. With GAAP, you amortize them over the shorter of their useful life or the remaining lease term. Keep in mind, leasehold improvements are qualified improvement property under the 2017 TCJA, alongside building improvements, restaurant property, and retail improvements.
Types of Leasehold Improvements
Let's look at the main types you might encounter. First, there's the tenant improvement allowance, where you as the tenant oversee the project, and the landlord provides a budget—either a lump sum or per square foot. The landlord pays the contractor or reimburses you, but you cover any overages. Then, rent discounts let the landlord offer free or reduced rent periods so you can fund the improvements yourself, again overseeing the work and paying extras. Building standard allowance, or build-out, means the landlord offers a package of options and manages the project, giving you more time for your business, though you might not get exactly what you want and have to pay for add-ons. Finally, turn-key improvements happen at the lease start, where you submit plans and estimates, but the landlord supervises and pays for everything.
Leasehold Improvements Rules
Rules have evolved, so pay attention. The 2015 PATH Act made 15-year straight-line depreciation permanent for qualified improvements, but only if landlords and tenants weren't related, improvements were interior and tenant-specific, and done after three years of building occupancy. The 2017 TCJA relaxed this—no more unrelated parties requirement, and it dropped the three-year wait, allowing improvements after the property's first placed in service. Still, exclusions like enlargements, elevators, roofs, fire systems, alarms, security, and HVAC apply. The 2020 CARES Act set a 15-year recovery for qualified improvement property and allowed first-year bonus depreciation.
Accounting for Leasehold Improvements
You can't deduct these improvements outright, but since they're part of the building, you depreciate them. The IRS allows this if conditions are met, and whoever pays for the work takes the deduction—landlord or tenant. TCJA bumped the max to $1 million from $500,000. For accounting, expense small ones under your capitalization limit in the same period; capitalize and amortize larger ones over the lease term or improvement life, whichever is shorter. If you finance them, lenders typically won't extend terms beyond the lease life.
Leasehold vs. Building Improvements
Don't confuse the two: leasehold improvements benefit just one tenant and are specific to their space, while building improvements help everyone and alter the overall structure, extending its life. Examples of building ones include new roofs, paving driveways or lots, lobby renovations, elevator repairs, or HVAC updates.
Examples of Leasehold Improvements
Here's a straightforward example: a landlord adds four walls to a leased space for a disc golf shop to create displays and storage—that's a leasehold improvement. Another: a retail store leases space with just walls, and the landlord installs shelving, a service counter, and special lighting display units before opening. These are tenant-specific and paid via allowances or discounts.
Frequently Asked Questions
- What are examples of leasehold improvements? They include anything benefiting one tenant, like painting, new walls, display shelves, flooring or lighting changes, or adding offices and partitions.
- Who pays for leasehold improvements? Landlords cover them through allowances, rent discounts, or packages, but tenants pay overages.
- Are leasehold improvements tax deductible? No direct deduction, but you can depreciate them as part of the building.
The Bottom Line
In summary, leasehold improvements are custom fixes to rental units for a specific tenant, like painting or fixture replacements. You can't deduct them directly, but depreciate over time per IRS rules, and they differ from broader building improvements.
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