What Is a Leasehold?

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.

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.

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.