How do you account for leasehold improvements in your financial statements?

1 Leasehold improvement accounting for tenants

As a tenant, you may pay for some or all of the leasehold improvements yourself, or receive a tenant improvement allowance from the landlord. Either way, you need to record the cost of the leasehold improvements as an asset on your balance sheet and amortize it over the shorter of the lease term or the useful life of the improvements. Amortization is the process of allocating the cost of an asset over its expected benefit period. You also need to record a corresponding liability if you received a tenant improvement allowance, and reduce it as you make lease payments.

2 Leasehold improvement accounting for landlords

As a landlord, you may provide a tenant improvement allowance to attract or retain a tenant. This is a payment or rent reduction that covers some or all of the cost of the leasehold improvements. You need to record the tenant improvement allowance as an asset on your balance sheet and amortize it over the lease term. You also need to record a deferred rent revenue liability and recognize it as income over the lease term. If you pay for the leasehold improvements directly, you need to record them as an asset and depreciate them over the useful life of the improvements.

3 Leasehold improvement taxation for tenants

As a tenant, you may be able to deduct the amortization of the leasehold improvements as a business expense on your income tax return. However, you need to follow the rules and limitations of the Internal Revenue Service (IRS) for leasehold improvement property. For example, the improvements must be made under or pursuant to a lease, placed in service more than three years after the building was first placed in service, and benefit only the leased space. You also need to determine the depreciation method and recovery period for the leasehold improvements, which may vary depending on the type and date of the improvements.

4 Leasehold improvement taxation for landlords

As a landlord, you may be able to deduct the depreciation of the leasehold improvements or the tenant improvement allowance as a business expense on your income tax return. However, you also need to follow the rules and limitations of the IRS for leasehold improvement property. For example, you may have to allocate the tenant improvement allowance between rent and improvement costs, and report the rent portion as income. You also need to determine the depreciation method and recovery period for the leasehold improvements, which may differ from the tenant's method and period.

5 Leasehold improvement implications for commercial leasing

Leasehold improvements can have significant implications for both tenants and landlords in commercial leasing. They can affect the rent amount, the lease term, the security deposit, the maintenance responsibilities, and the renewal options. Therefore, it is important to negotiate and document the terms and conditions of the leasehold improvements in the lease agreement. For example, you may want to specify who owns the leasehold improvements, who pays for them, who is responsible for repairs and removal, and how they affect the rent and lease term.

6 Leasehold improvement best practices for commercial leasing

To ensure accurate accounting for leasehold improvements in your financial statements, you should plan ahead and budget for them before signing the lease agreement. Carefully review the lease agreement and understand your rights and obligations regarding the improvements. Additionally, keep accurate records of the improvements, including invoices, receipts, contracts, and permits. Make sure to report the leasehold improvements correctly on your financial statements and income tax return, following the applicable accounting standards and tax rules. If needed, seek legal and accounting advice and consult a professional accountant.

7 Here’s what else to consider

This is a space to share examples, stories, or insights that don’t fit into any of the previous sections. What else would you like to add?