What Is a Leasehold?

A leasehold is an accounting term for an asset being leased. The asset is typically property such as a building or space in a building. The lessee contracts with the lessor for the right to use the property in exchange for a series of scheduled payments over the term of the lease. Renting space in an office building for a company's use or renting a building to be used for a retail store are two examples of a commercial leasehold arrangement.

Key Takeaways

  • A leasehold is an accounting term that refers to an asset or property that a lessee (tenant) contracts to rent from a lessor (property owner) for an agreed-upon time in exchange for scheduled payments.
  • Owners of retail stores often use leasehold arrangements for their businesses rather than constructing their own buildings.
  • The leasehold contract for commercial properties can be complex agreements that stipulate such things as the payment structure, breach of contract clauses, and leasehold improvement clauses.
  • The contract will stipulate which party is responsible for making leasehold improvements, which might include such things as building walls and partitions, adding lighting fixtures, or constructing shelves.
  • The IRS does not allow leasehold improvements to be deducted. However, the improvements are subject to depreciation.

Understanding Leaseholds

A leasehold contract will stipulate the terms of the agreement between the lessee (tenant) and the lessor (property owner or landlord). The contracts for commercial properties—such as space in an office building—are generally complex agreements that stipulate landlord responsibilities, tenant responsibilities, security deposits, breach of contract clauses, and leasehold improvement clauses. Larger tenants may be able to request more favorable terms in exchange for leasing more space for a longer time. Leases for commercial properties typically run from one to 10 years.

Types of Leaseholds

There are different types of leaseholds, including tenancy for years, periodic tenancy, tenancy at sufferance, and tenancy at will.

Tenancy for Years

A tenancy for years is a type of contract in which the details are spelled out, including the duration of time a renter will reside in the property and the payment that is expected. The contract could last for days or years, but is characterized by a specific starting and ending date.

Periodic Tenancy

With a periodic tenancy, the renter's time in the property is contracted for a non-specified period of time, with no agreed-upon expiration date. The terms of the rental were initially specified for a certain period of time, but the end date continues until the owner or renter gives a notice to terminate. For example, a yearly contract might end, but then evolve into a month-to-month contract, in which only one month's notice is needed to terminate.

Tenancy at Sufferance

A tenancy at sufferance is when the renter's tenant has expired, but the renter refuses to vacate the property, and is therefore staying without the owner's consent. Typically, this results in the owner instigating eviction proceedings. However, if the landlord accepts a rent payment after the lease has expired, the property is considered to be leased again on a month-to-month basis.

Tenancy at Will

A tenancy-at-will is a type of leasehold that can be terminated at any time by either the owner/landlord or the tenant. The arrangement does not include the signing of a contract or lease and generally does not specify the length of time a tenant will use the rental or any specifics about payment. The agreement is governed under state law, with varying terms based on the state. Federal law is applicable in cases of discrimination. 

Leasehold Improvements

After a lease agreement has been finalized, the lessee, or tenant, begins to build out the space for its purposes to the extent allowed by the contract. Work on walls, ceilings, floor space, lighting fixtures, additional plumbing fixtures, shelving, and cabinets represent leasehold improvements that are recorded as fixed assets on a company's balance sheet.

Depending on the contract, leasehold improvements might be paid for by the tenant, the landlord, or a combination of both. Some landlords may agree to pay for leasehold improvements in order to entice a new tenant to sign a lease. However, when demand is high for a building or office space, the landlord may not be willing to incur the additional expense for leasehold improvements. Leasehold improvements that are permanently affixed to the building often remain the property of the landlord even after the lease ends.

Leasehold improvements are made to the interior of a building; modifications made to the exterior of a building are not considered leasehold improvements.

Example of a Leasehold

Leaseholds are most common for brick-and-mortar retailers. Best Buy Co., Inc. is an example. The company leases a majority of its buildings and makes leasehold improvements that suit its standardized interior functional and aesthetic design. Most of the company's leases contain renewal options and escalation clauses, as well as contingent rents based on specified percentages of revenue, which is a common clause in lease agreements for retailers.

Rent expense is recognized on a straight-line basis to the end of the initial lease term, and any difference between straight-line expense amounts and rent payable is booked as deferred rent. For some retailers, leasehold improvements are a significant portion of gross property and equipment expenses.

Leasehold Interest

A leasehold interest is a contract in which an individual or entity, or in real estate terms, a lessee, leases a parcel of land from an owner or lessor for a set period of time. The lessee has the exclusive rights to possess and use as an asset or property for the specified period of time. There are four types of leasehold interests, as mentioned above: tenancy for years, periodic tenancy, tenancy at sufferance, and tenancy-at-will.

Leasehold interest most often refers to a ground lease and tends to therefore last for multiple years. For example, an individual might lease a lot from an owner for 40 years and choose to build a property on the grounds. That individual could then rent out the property and earn rental income, but still has to pay the owner for the right to use the lot.

A leasehold interest differs from a freehold interest, or fee simple interest, in which an individual or entity has total ownership over the land or property and can use it in whatever way they see fit.

Leasehold FAQs 

What Is a Leasehold Estate?

A leasehold estate is an agreement that a tenant can use an owner's property for a set period of time. The estates are often backed up by contracts or lease agreements that lay out the duration of the rental, the terms and conditions of use, the payment required, and the landlord's obligations to the tenant.

How Do You Depreciate Leasehold Improvements?

The IRS does not allow leasehold improvements to be deducted. However, since improvements are part of the building, they are subject to depreciation. Leasehold improvement depreciation should follow a 15-year schedule that has to be re-evaluated each year based on its useful economic life.

Which Type of Leasehold Has a Definite Beginning and Ending Date?

A tenancy for years, in which the contract is specified, including a clear beginning and ending date.

The Bottom Line

A leasehold is an asset being leased, such as a building or unit in a building. A renter makes a contract with the owner or landlord to use the property in question, in exchange for a series of payments over the duration of the lease. A commercial leasehold involves renting space for the purpose of operating a store, doctor's office or other business, and a residential leasehold is for a property to be occupied for personal use.