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Leasehold Improvements: What They Are and How They Work

Leasehold improvements are modifications to the interior of a leased building to make it more useful or desirable to the tenant. They are sometimes also referred to as build outs or tenant improvements, and they can be a form of lease incentive.

A landlord may initiate leasehold improvements to their property to attract tenants, or they may agree to make them as a lease incentive during negotiations with a prospective tenant. A tenant may also request or initiate leasehold improvements during the course of their lease.

What qualifies as a leasehold improvement?

Although there are many ways by which a landlord can improve their property, not all of them are considered leasehold improvements. It’s only a leasehold improvement if it is done to the interior of the building and meets specific criteria.

Changes made to the exterior of the building, changes to the property grounds, and building improvements that benefit multiple tenants are not considered leasehold improvements. Furthermore, repairs and common area maintenance also do not qualify as leasehold improvements.

So what does qualify? Examples of common leasehold improvements include:

  • Repainting the walls
  • Dividing a space into separate rooms with partitions
  • Adding carpet, tiles, or other floor finishing
  • Installing fixed pieces of equipment
  • Upgrading light fixtures

For something to count as a leasehold improvement, it must actually be attached to the building. Moveable furniture or equipment does not qualify. This can sometimes make for a fine line between what is and isn’t a leasehold improvement. For example, adding a table may or may not be a leasehold improvement depending on whether it is sitting freely or bolted to the floor.

In commercial applications, leasehold improvements are often necessary changes to meet the tenant’s business needs. For example, a retailer may need shelving, checkout counters, and security cameras installed. Or an office space may need partitions to divide a large area into individual workstations.

Who pays for leasehold improvements?

Generally, leasehold improvements belong to the landlord and stay with the property after the lease has expired. For this reason, the landlord often pays for leasehold improvements or reimburses the tenant for making them. However, it isn’t always that straightforward.

Sometimes tenants will pay for leasehold improvements that they can later uninstall and take with them. And in other cases, the landlord may be unwilling to cover leasehold improvements that a tenant needs, but they cannot be uninstalled, and so the tenant pays for them knowing the improvements will ultimately belong to the landlord.

When the landlord pays for leasehold improvements, they usually use one of four methods:

  • A tenant improvement allowance
  • A build-out allowance
  • A rent discount
  • A turnkey project

Tenant improvement allowances (TIA)

A tenant improvement allowance (TIA) is the most straightforward method by which a landlord may pay for leasehold improvements. The landlord simply gives the tenant the agreed-upon funds, and the tenant oversees the improvements, using the funds from the landlord to pay for them.

Build-out allowances

A build-out allowance, also referred to as a building standard allowance, comes in the form of a predefined package of improvements. The landlord specifies a set of upgrades that may include things like new flooring, light fixtures, partitions, and paint, each at a particular price and quality level. The tenant may simply accept the package as is, or they may pay for individual upgrades beyond what the package includes by default. The landlord will then oversee the improvements.

Rent discounts

A rent discount allows the landlord to pay for leasehold improvements indirectly by offering rent that is either free or at a discounted rate for a specified number of months. They do this with the understanding that the tenant will then apply those savings toward making the leasehold improvements instead. The tenant oversees the improvements.

Turnkey projects

A turnkey project is a proposal for leasehold improvements submitted by the tenant, including plans and the estimated cost. If the landlord approves of the proposal, then they pay for and oversee the improvements.

How are leasehold improvements taxed?

Leasehold improvements are capitalized and amortized over the shorter of either the length of the lease or the life of the improvement. At one point, leasehold improvements meeting certain criteria qualified for a 15-year depreciation bonus; however, this changed with the Tax Cuts and Jobs Act (TCJA), and they are now depreciated over 20 years or more. Furthermore, TCJA now treats leasehold improvements, building improvements, qualified restaurant property, and qualified retail improvement the same for tax purposes.

Make lease management easy

Negotiating for leasehold improvements is just one small part of lease administration. You’ll need to keep track of important dates, manage renewals, review clauses, prepare lease abstracts, and much more.

Tango Lease gives you the tools to easily handle all of it, streamlining your processes to save valuable time.

All of your lease-related information gets organized into intuitive dashboards, equipping you to manage lease accounting schedules, avoid overcharges, maintain compliance with the latest lease accounting standards, and perform lease activities. With Tango Lease, your team can analyze and explore your entire lease portfolio from the same place.

See what our lease administration and accounting software can do for your organization.

Schedule a demo of Tango Lease today.

Contributors

Rick Zelinsky

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