Leasehold improvements: A complete guide

Alterations or renovations made to a leased property with the tenant in mind are often considered leasehold improvements. These improvements can be made by either a landlord or the tenant themselves, and generally include common interior adjustments like hanging drywall, installing new flooring or painting. Fixing up a space usually has a positive connotation, but these alterations come with their own set of considerations for tenants and landlords. To better understand these types of buildouts, let’s examine how leasehold improvements function and how you may want to navigate them, whether you’re renting or managing a property.

What is a leasehold improvement?

Depending on the length of a lease, chances are that some upgrades will be appreciated during a tenant’s time at a property. Often, these changes will be made prior to the tenant moving in. To be considered leasehold improvements, the work must be in the interest of the tenant, though it could come at the suggestion of the landlord. Once it’s time to put the work in, either party may end up managing the buildout or installation depending if the improvement and what was agreed upon.

While a property may require both internal and external upgrades during a tenancy, only interior modifications to a specific tenant’s space are considered leasehold improvements. Any improvements made to the exterior of the building, its foundation or that serve multiple tenants are considered building improvements. It’s also worth noting that while leasehold improvements may apply to residential properties in some cases, they’re more typically associated with commercial spaces. Let’s take a closer look at what might be considered a leasehold improvement and which common upgrades aren’t.

Examples of qualified leasehold improvements

• Cubicle installation
• Lighting adjustment or installation
• Building out new walls and floors
• Installing shelving and partitions
• Electrical and technical updates in the tenant’s space
• Painting interior walls

Examples of unqualified leasehold improvements

• HVAC installation or upgrade
• Enlargement of the building
• Escalator or elevator installation or upgrade
• Landscaping
• Parking lot repairs
• Roofing repairs
• Any other upgrades that serve the building as opposed to a specific tenant

Why make leasehold improvements?

Making leasehold improvements could benefit both the tenant and the owner of a property. While tenants certainly appreciate any effort put into their space, being open to making these improvements and adapting to tenants could create, strengthen and maybe even lengthen a tenant’s time at a property. One example would be if a fashion retailer was looking at a space with just four walls built out. The promise of leasehold improvements such as custom shelving or rack installation may influence them to sign a lease for the space.

Additionally, because they technically own the leasehold improvements, landlords may be able to repurpose tenant improvements down the line, depending on the needs of future leaseholders.

Types of leasehold improvements

Now that we’ve answered the question “What are leasehold improvements?”, let's examine the four types of leasehold improvements that tenants and owners may agree upon. Each situation varies in terms of who is responsible for the improvements and how they’re paid for.

• Turnkey: In a turnkey leasehold improvement, the landlord or property manager pays for and oversees all the work before you move into the space.
• Rent discount: Sometimes a landlord will offer you free or discounted rent for a period of time if you’re seeking leasehold improvements. The expectation here is that you use those savings to pay for the work that’s needed. In this situation, you’ll be expected to oversee the upgrades or buildouts.
• Building standard allowance: This type of leasehold improvement, also known as a “build out allowance,” is a package offered by the landlord or property manager. The package will generally offer a selection of improvements the landlord is prepared to pay for, but all other improvements are generally covered by the tenant.
• Tenant improvement allowance (TIA): In this situation, a landlord will offer you a tenant improvement allowance (TIA) to cover improvements, which you’ll then oversee. With a TIA, the money allotted towards improvements is generally by the square foot. For example, if the space is 900 square feet, you may receive $20 per square foot for desired upgrades.

What happens at the end of the lease term?

At the end of a lease, the landlord generally owns the improvements. Sometimes, however, a tenant will have ownership of any leasehold improvements as well as the responsibility of their removal before vacating the space. Make sure you understand your responsibility, if any, before agreeing to any upgrades.

In summary

Leasehold improvements are any upgrades or renovations made to a space with the specific tenant in mind. In some cases, the landlord will be responsible for the work, like when home renovations are made on a tenant’s behalf. In other cases, however, the tenant might oversee the upgrades with the help of a landlord-provided allowance. Leasehold improvements not only help tenants who need customized renovations but also give landlords the opportunity to attract tenants and possibly keep them when it’s time for a lease renewal. Because what’s considered a leasehold improvement is specific (and only applies to interior work), it’s generally a good idea to keep the nuances in mind if you’re seeking this type of renovation as a tenant. Additionally, leaseholds require specialty underwriting and are subject to approval - may be permitted based on exceptions per investor.

FAQs

Are leasehold improvements depreciated or amortized?

Depending on the type of leasehold improvements, and who owns or handles them, they could be depreciated or amortized. Consider speaking with a trusted tax professional to figure out which situation applies.

What happens to leasehold improvements when lease expires?

Once a lease expires, the landlord will often have ownership of any leasehold improvements and can address them as desired. Other times, when the tenant is responsible for the improvements, they may need to remove them from the premises.

Are leasehold improvements tax deductible?

In some situations, leasehold improvements may be tax deductible. Because there are different types of leasehold improvements, it’s best to speak to a qualified tax professional for advice regarding your unique situation.

Who pays for leasehold improvements?

Either the landlord or the tenant will generally pay for leasehold improvements. Because the responsibility differs based on the type of leasehold improvement, it’s best to figure out which situation applies to you. As an example, if the leasehold improvements are of the turnkey variety, it’s going to be the landlord who takes financial and managerial responsibility for the upgrades. If you’re navigating a rent discount situation, it’s usually the tenant who oversees and pays for the leasehold improvements.

Who owns leasehold improvements?

While the landlord generally tends to own the improvements, each leasehold improvement situation is different, and the tenant may occasionally retain ownership of whatever upgrades were made.