Leaseholder or Tenant Improvements
Leasehold improvements are also known as tenant improvements or build-outs. They are modifications made by the property owner or the leaseholder to render the space more useful or appealing for the tenant.
Leasehold improvements are a common practice in commercial real estate spaces. In these commercial properties, the building owners want to attract and retain tenants for the longest possible terms. These improvements may also be provided as part of a new lease negotiation.
What Is and Is Not an Improvement?
Leasehold improvements are typically made by the owner. Interior spaces are modified according to the operating needs of the tenant—for example, changes made to ceilings, flooring, and inner walls.
Alterations to the exterior of a building or modifications that benefit other tenants in the building are not considered leasehold improvements. Examples of non-leasehold improvements include elevator upgrades, roof construction, and the paving of walkways.
Leasehold improvements are designed to meet the operational needs and preferences of the tenant.
A company that has a call center might need small cubicles and telephones to be installed. A doctor's office might need a series of consulting rooms with more open spaces for nurses and administrators.
The retail industry is rife with leasehold improvements because each tenant requires a specific layout and design. Typical leasehold improvements in retail include partitioning of a large, open space into smaller, more structured areas. Construction of dressing rooms, installation of retail shelving and reception counters, floor replacement, specialized lighting, and technology systems.
Landlords often offer payment or a discount on rent so that tenants can make necessary commercial leasehold improvements themselves.
Paying For Modifications
There are four main ways a landlord will pay for commercial leasehold improvements: tenant improvement allowances, rent discounts, building standard allowance, and turnkey projects.
Tenant Improvement Allowance (TIA)
With a tenant improvement allowance (TIA), the landlord gives the tenant a certain amount of money to cover the improvements, and the tenant oversees the work. The amount received varies based on several factors and based on square footage. For example, $10 to $20 per square foot.
Since the 2018 Tax Cuts and Jobs Act (TCJA), building improvements, leasehold improvements, qualified restaurant property, and qualified retail improvements are now treated as qualified improvement property (QIP) for tax purposes.
In some cases, a landlord may offer free rent or a discount on rent for a certain number of months. The renter uses the savings to pay for improvements and oversees the work. A renter might receive four months of free rent over the course of a four-year lease, for example.
Building Standard Allowance
This allowance is also known as a "build-out" allowance. The landlord may offer an improvement package that is composed of types of flooring and fixtures and fittings at a certain price. The renter selects items from the package but must pay for any improvements that are not included in the package. In this case, the landlord oversees the improvement work.
For turnkey projects, the renter submits an improvement plan with cost estimates. The landlord pays and oversees all of the work.
Tax Treatment of Leasehold Improvements
Leasehold improvements are considered capital and are amortized over the length of the lease. Originally, building improvements, leasehold improvements, qualified restaurant property, and qualified retail improvement were all treated differently.
Now, since the 2018 Tax Cuts and Jobs Act (TCJA), they are rolled into one and known as qualified improvement property (QIP). Notably, the 15-year depreciation bonus is no longer in the new tax law, and depreciation takes place over 20 or more years.
- Leasehold improvements are also called tenant improvements or buildouts.
- The property owner typically makes modifications to a commercial real estate space to accommodate the needs of the tenant.
- Leasehold improvements are applied to the interior space, such as the ceilings, walls, and floors.
- Modifications to the exterior of a building are not considered leasehold improvements.