What Is a Leasehold Improvement

There are many businesses that require to customize their space for the specific purpose of having enough or the right type of space for their business. This type of customization is called Leasehold Improvements. And for those who have leased property for many years, having a good understanding of what this is, and how it impacts the property can be very important.

So, if you are a business owner who is looking to lease property, or you are currently leasing property, it’s important to know about Leasehold Improvements. To know what qualified leasehold improvements are, what is tenant improvement, and other necessary things to make the best decision for your business, keep on reading.

What is a Leasehold Improvement?

When you are looking for a rental property or commercial property for your business, it is often times that the property itself doesn’t have the specific amenities, build-outs, or space for your business needs. Lease improvements or building improvements are those that are made to the property in order for it to better fit your business. These are often negotiated during the initial lease term agreement.

Depending on the marketability of the property, the property owner might provide improvement incentives in the form of a Tenant Improvement Allowance.

What is Tenant Improvement Allowance?

A Tenant Improvement Allowance (TIA) is an incentive that is provided by the property owner to the tenant, in order to help cover the costs of leasehold improvements. The TIA is often times given as a lump sum payment, or it can be spread out over the course of the lease. There are also some instances where you, the lessor, should provide the upfront cost for the building improvement which will later be reimbursed by the tenant through their monthly lease payments.

Other Types of Leasehold Improvements

During the lease agreement, landlords often present you with other options that are considered leasehold improvements aside from Tenant Improvement Allowance. This can include:

Rent Discount

As the name suggests, a rent discount is when the landlord agrees to give you a lower monthly rental rate in exchange for you agreeing to make specific leasehold improvements to the property. This can also be a month or two of free rent to cover the cost of improvements.

Building Standard Allowance

Also known as the build-out, where the landlord presents an improvement package that you can choose from. These are pre-determined tenant improvements that the landlord has deemed necessary for the property, and they agree to cover the cost of these improvements. In this option, the landlord typically manages the project so tenants can focus more on their business. However, the downside of this option is that modifications often end up not having the modification they specifically need. If you, the tenant wish to add or change anything, it will likely need to be approved by the landlord and will come at an additional cost to you.

Turn Key

Unlike on the remaining lease term, the turn key is offered on a brand new lease. The useful life of the improvement will be maximized as it will be used for the entirety of the lease. You will need to provide the cost estimates and plans to the landlord for approval, and once it is approved the landlord will be responsible for the entire cost of the improvement.

Leasehold Improvement Rules

There are some general rules when it comes to leasehold improvements, and these include:

• Tenants and landlords are not allowed to be related to one another.
• The lease agreement must be for a minimum of 15 years.
• The build-out or improvement must be made after the lease agreement is signed.
• The leasehold improvements are required to be completed after three years of the building being constructed.

However, with the passing of the Tax Cuts and Jobs Act in 2017, these rules have changed. The qualified improvement property no longer requires both the landlord and tenants to be unrelated and the three-year requirement that says the property must be held for at least three years has been removed according to the Internal Revenue Service.

What are the Examples of Leasehold Improvements

There are many examples of leasehold improvements, but some common leased space improvements include:

• Painting
• Adding new walls
• Adding shelves
• New flooring
• Lighting
• Other things that will benefit the specific tenant and their business needs

Are Leasehold Improvements Tax Deductible?

No. You can’t deduct the cost of leasehold improvements from your taxes. But, the IRS allows the owner to account for their deprecation because all changes made are considered to be capital improvements and are part of the building.

The Bottom Line

When leasing, it is important to know all your options for leasehold improvements as this can help you save money and get the most out of your lease agreement. Negotiate with your landlord on what they are willing to cover and be sure to get everything in writing.