2025 Guide: How Long Can Building Owners or Landlords Depreciate Leasehold Improvements? Costs & Rules Explained

A leasehold improvement refers to modifications made to a rental property to tailor it specifically to a tenant's needs. Common examples include painting, installing partitions, upgrading flooring, or adding custom lighting fixtures. These improvements can be undertaken by landlords aiming to enhance their property's appeal or directly by tenants.

According to the Internal Revenue Code, leasehold improvements are eligible for a 15-year depreciation period if they meet specific criteria: they must be made following lease terms, occur more than three years after the building's initial use, and must not expand or change the building's structural framework.

In contrast, U.S. Generally Accepted Accounting Principles (GAAP) treat leasehold improvements differently. Under GAAP, these improvements are amortized over the shorter period between their useful economic life or the remaining lease term.

Key Insights

• Leasehold improvements customize rental spaces to fit tenant requirements.
• The IRS classifies these improvements as capital expenditures, not immediate business expenses, making them subject to depreciation.
• GAAP requires amortization over the lesser of the improvement's useful life or the lease's remaining term.

Understanding Leasehold Improvements

Also called tenant improvements or build-outs, leasehold improvements are primarily made by commercial property landlords to accommodate tenant needs. These changes are limited to the interior of the leased space and do not include exterior building or landscape modifications.

For example, roof replacements, elevator upgrades, or parking lot paving are not considered leasehold improvements because they benefit the entire property rather than a specific tenant.

Typically, once a lease expires, ownership of the improvements reverts to the landlord unless the lease agreement specifies otherwise. Tenants permitted to remove improvements must do so without damaging the property.

GAAP Financial Reporting

Under GAAP, whether leasehold improvements are capitalized or expensed depends on a company’s capitalization threshold. Improvements below this limit are expensed immediately, while those exceeding it are capitalized and amortized.

Capitalized leasehold improvements are amortized over the shorter of the asset’s useful life or the lease’s remaining term. Management estimates the useful life, and foreseeable lease extensions can be included in the amortization period.

If the property is purchased, the lease terminates, and the leasehold improvements are amortized over the remaining useful life of the building.

U.S. Tax Basis Financial Reporting

The American Jobs Creation Act of 2004 introduced a faster 15-year depreciation schedule for leasehold improvements, replacing the previous 39-year term. This accelerated depreciation was made permanent in 2015 and applies to qualifying commercial, restaurant, and retail buildings.

Landlords and building owners should ensure improvements meet IRS criteria to benefit from this accelerated depreciation, optimizing tax advantages and financial reporting accuracy.

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