What is a Leasehold Improvement
A leasehold improvement is a change made to a rental property to customize it for the particular needs of a tenant. Leasehold improvements, such as painting, installing partitions, changing the flooring or putting in customized light fixtures can either be undertaken by landlords, who may offer to do so to increase the marketability of their rental units, or by the tenants themselves. While the useful economic life of most leasehold improvements is 5 to 10 years, the Internal Revenue Code requires that depreciation for such improvements to occur over the economic life of the building or 15 years.
BREAKING DOWN Leasehold Improvement
Landlords may pay for leasehold improvements to encourage tenants to rent spaces for longer durations. A business owner, for example, is leasing a building for her disc golf shop. The landlord adds four walls to the leased area and creates built-in displays and storage areas for the discs. These alterations are considered leasehold improvements.
Ways a Landlord Pays for Leasehold Improvements
A landlord may pay for commercial leasehold improvements through a tenant improvement allowance (TIA). In this case, the landlord allows a set budget for improvements, typically $5 to $15 per square foot, and oversees the project. Meanwhile, the tenant controls the renovation process, which may be time-consuming. If project budgets are exceeded, the tenant covers the balance.
Rent discounts may be offered for leasehold improvements as well. The landlord offers the tenant free or reduced rent for a set number of months, such as one free month per year on the lease, as a means for the tenant to save on space alterations. The tenant typically oversees the project and has control over the lease improvements. The tenant is also responsible if costs exceed the budgeted amounts. In addition, rent may be raised at a later date, causing the tenant to pay more for the space long term.
Another type of leasehold improvement is a building standard allowance. The tenant may decide among various selections the landlord provides, such as one of four colors of paint. These items might not meet the tenant’s needs, and he might not be satisfied with the results. Additional improvements are covered by the tenant. The landlord oversees the project.
Internal Revenue Service Alterations to Leasehold Improvement Rules
In December 2015, the United States Congress passed the Protecting Americans from Tax Hikes (PATH) Act, which modified and extended many tax provisions related to depreciation, including leasehold improvements. The act made permanent a tax-savings provision that allows for 15-year straight-line cost recovery on qualified leasehold improvements.
This bonus depreciation became available for leasehold improvements made to the interior of the building, and made under a lease with only that tenant occupying the space. Also, the landlord and tenant may not be related, and the leasehold improvement must be completed after three years of the building first being occupied for service. Under the Act, building enlargements, elevators, escalators, structural components in a common area and structural framework in the building are not considered leasehold improvements.