How Long Can a Building Owner or Landlord Depreciate a Leasehold Improvement?

A leasehold improvement is a modification made to a rental property to customize it to the particular needs of a tenant. Tenant improvements, such as painting, installing partitions, changing flooring or installing custom light fixtures can be undertaken either by the owners— who can offer to do so to increase the market value of their rental units — or by the tenants themselves.

While the useful economic life of most leasehold improvements is five to 15 years, the Internal recipe code require that depreciation for these improvements to occur over the economic life of the building.

Leasehold improvements have different depreciation rules depending on whether you are working with US tax-based or US-based financial reporting. generally accepted accounting principles (GAAP) financial reporting. For tax purposes, leasehold improvements can be amortized over periods of up to 15 years.

Key points to remember

  • A leasehold improvement is a modification made to a rental property to customize it to the particular needs of a tenant.
  • The IRS does not allow deductions for tenant improvements. But because improvements are considered part of the building, they are subject to depreciation.
  • Under GAAP, amortization of leasehold improvements must follow a 15-year schedule, which must be reassessed annually based on its useful economic life.

Understanding Tenant Improvements

Rental improvements are also known as leasehold improvements or constructions and are usually done by commercial property owners. Landlords can provide these upgrades to existing or new tenants. Changes are tailored to the needs of a specific tenant and their needs. Only improvements made inside a specific tenant’s space are considered tenant improvements.

Tenant improvements, as noted above, apply to structural changes to the space that will benefit a particular tenant. Thus, making changes to a tenant’s space does not constitute a tenant improvement for the neighbour.

Changes to the exterior of a building or its landscape also do not apply. If a landlord replaces the roof of the building, improves the elevator or paves the parking lot, none of these changes are considered tenant improvements because they do not benefit any particular tenant.

Once the to rent out purposes, improvements generally belong to the owner, unless otherwise specified in the agreement. If the tenant is able to take them away, he must remove them without damage to the property.

GAAP financial reports

For GAAP financial reporting, enhancements to leases may be capitalized or expensed depending on the dollar amount of the improvement. Companies set a capitalization limit, a accounting standard determined by management which sets the threshold amount above which an item is capitalized rather than expensed.

If the amount does not exceed the funding limit, the leasehold improvement is expensed in the period in which it is incurred. If, however, the cost exceeds the capitalization limit, the company capitalizes and amortizes it.

Under GAAP, a capitalized leasehold improvement is amortized over the lesser of the remaining useful life or the remaining lease term. Useful life is determined based on management estimates.

In addition, the remaining term of the lease may include extensions as long as they are foreseeable and reasonably assured. If the building is subsequently purchased, the lease ceases to be in effect and the leasehold improvement would be amortized over the remaining useful life of the building.

U.S. Tax Basis Financial Reporting

The 15-year rule was enacted by the Tax Service (IRS) in 2004. Prior to this year, the amortization period was 39 years. The 15-year rule is not permanent and must be renewed each year.

The amortization period is fixed regardless of the actual duration useful life the leasehold improvement or the remaining term of the lease.

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