How Does a Leasehold Improvement Function?

Feb 14, 2024 By Susan Kelly

Leasehold improvements are generally called building-outs or tenant improvements. These modifications are usually done by the commercial property owners and can be made available to tenants who are either new or existing. All changes are tailored to a tenant's particular requirements and help make the space more appealing to tenants. Certain criteria must be met for the changes to be considered leasehold improvements. The changes must be made in the interior of the property to meet the needs of the tenant, which could include the following:

  • Modifications to structural structures
  • New flooring and drywall
  • Updates to electrical, lighting technology systems, and lighting
  • The addition of rooms, cubicles, partitions, and rooms
  • Shelving and counters

Some changes are not legally considered to be leasehold enhancements. One tenant's changes do not qualify for the other tenants, even their neighbors. Renovations to exterior buildings, like landscaping, repairs to parking lots, or roofing, don't count also. Interior modifications, such as modifications to buildings' HVAC or elevator systems, aren't thought of as leasehold improvements. They don't benefit the tenant in question. After the lease expires, the improvements usually remain with the tenant except as stated in the lease. If the tenant has the right to acquire the improvements, they have to remove them with no harm or damage to the property.


Tenant Improvement Allowance

This kind of leasehold improvement allows the tenant to supervise the work, relieving the landlord, especially when the project is lengthy. The landlord usually includes provisions in the lease to cover the expenses of the tenant allowance improvements. It is typically stated in a lump sum or individually per square foot. Landlords may either pay the renovation company directly or reimburse the tenant directly. If budgets for the project are over, the tenant pays the remainder.

Rent Discount

The landlord might offer tenant discounts on rent in exchange for leasehold improvements. If this option is provided within the lease agreement, tenants could receive rent relief of a certain kind, like a no-cost month or reduced rates for specific periods throughout the year. This lets the tenant make space-saving changes. Like the TIA, The tenant is responsible for the project and oversees the lease changes. The tenant is also accountable for any costs that exceed the budget.

Building Standard Allowance

It is also known as the build-out. In this instance, the landlord offers an improvement plan or alternative alternatives at the tenant's request. The landlord usually oversees the project, giving the tenant more time to dedicate to the business. In most cases, tenants will not get the exact changes they need to grow their business. If they decide to make changes, they have to cover the cost of additional work.


The IRS doesn't allow deductions for improvement. However, since improvements are an element of the construction, they are subject to depreciation. The IRS permits depreciation deductions as the conditions are met. The person doing the work can claim the depreciation deduction regardless of whether the tenant is the landlord or tenant. The tax law passed recently has increased the maximum amount that can be claimed to $1 million, up from $500,000.

Accounting experts recommend putting any improvements that are less than the capitalization limit at the same time. If the improvements exceed this limit, the entire amount should be amortized and capitalized throughout the lease or the shorter period of the improvements.

Building Improvement and Leasehold Improvement

While they can be improvements to the building, leasehold improvements are different. They only have an effect on the property for a particular tenant. Improvements to buildings, on the contrary, are beneficial to everyone within the building and alter the structure of the building.

Some examples of improvements to buildings include the installation of a new roof, paving the driveway or parking lot, constructing a parking lot or a lobby that has been renovated, installing a new elevator, fixing an elevator that is already in place, or upgrading an HVAC system. In this way, improvements to the building can prolong its life.


Leasehold landlords can pay for improvements to help tenants lease spaces for longer durations of time, specifically in the retail sector. A business owner leases out a building for their disc golf store. The landlord could decide to build four walls on the area that is leased to build an area with built-in displays and storage for discs. These modifications are considered leasehold improvements.

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