Amortizing tenant and capital improvements in a commercial lease means spreading the cost of build-outs and building upgrades over the period they deliver value, rather than absorbing the hit in one year. Tenant improvements — interior work tailored to a specific occupant — are typically amortized over the lease term and repaid through a rent surcharge. Capital improvements — building-wide upgrades that extend the property’s useful life — are amortized over the asset’s useful life and passed through to tenants as part of Common Area Maintenance. On top of the lease-level math, the tax code sets its own recovery periods that determine when either party actually deducts the cost.
How a Tenant Improvement Allowance Becomes a Rent Surcharge
A tenant improvement allowance is a dollar amount the landlord commits to funding the build-out. It behaves like a loan embedded in the lease: the landlord fronts the construction cost, and the tenant repays it through a fixed monthly surcharge added to base rent. That structure lets a business preserve cash for operations instead of sinking it into fixtures permanently attached to someone else’s building.
The math is straightforward. Take the total allowance, add a negotiated interest rate that reflects the landlord’s cost of capital and risk, and divide the result into monthly installments over the lease term. A $200,000 allowance on a ten-year lease produces a monthly surcharge of roughly $2,400 to $2,700 depending on the rate. The surcharge sits as a separate line item, distinct from variable costs like utilities or property taxes.
Early termination is where these clauses bite. Most commercial leases include acceleration or buy-out language requiring the tenant to pay the remaining unamortized balance if the lease ends before its term runs out. A tenant who walks three years into a ten-year deal has repaid only a fraction of the build-out cost, and the acceleration clause makes the shortfall due immediately as additional rent. Negotiating a cap on the acceleration amount, or a declining balance schedule, is worth pushing for before signing. Once default triggers the clause, the full remaining balance typically comes due at once.
How Capital Improvements Flow Through CAM Charges
Building-wide upgrades like a new roof, elevator modernization, or a central HVAC replacement benefit every tenant but cost the landlord a large sum up front. Landlords typically amortize the expense over the improvement’s useful life and pass through only the annual amortized portion as part of Common Area Maintenance. A $500,000 roof amortized over 20 years produces a $25,000 annual charge, allocated among tenants proportionally by square footage.
Several lease provisions govern how that amortization actually works. The lease should define what counts as a capital improvement versus a repair, set the method for determining useful life, and address whether the landlord can add interest to the unamortized balance. Well-drafted leases require useful life to follow generally accepted accounting principles rather than a period the landlord picks. A shorter amortization compresses the same cost into higher annual charges, so the incentive to shorten it is real. Some leases cap the interest rate on the unamortized balance at prime plus a small margin; others leave it open.
Tenants should also confirm that capital improvement charges stop at lease expiration. If a roof goes on in year eight of a ten-year lease with a 20-year useful life, the tenant should owe only two years of amortized charges, not the full twenty. Language limiting payment to the remaining lease term protects against that outcome. CAM audit disputes often turn on whether an expenditure was truly a capital improvement or deferred maintenance the landlord should have covered as an operating expense years earlier.
Useful-Life Benchmarks
Industry standards published by the Building Owners and Managers Association (BOMA) provide widely referenced useful-life benchmarks. Roofing ranges from 15 to 35 years depending on material, with metal standing-seam roofs sometimes lasting 75 years or more. HVAC equipment typically runs 18 to 30 years, with packaged rooftop units at the shorter end and cast-iron boilers at the longer. Elevators span 15 to 50 years, with hydraulic units at 15 and traction elevators up to 50.
These figures matter because a landlord who amortizes a 20-year roof over 10 years effectively doubles the annual pass-through. Tenants reviewing CAM reconciliations should compare the landlord’s chosen useful life against BOMA or similar industry data and push back when the numbers don’t line up.
Tax Depreciation Runs on Its Own Schedule
Lease amortization and tax depreciation are separate calculations that both apply to the same improvement. A standard nonresidential building depreciates over 39 years under the Modified Accelerated Cost Recovery System. Interior improvements to an existing commercial building, however, qualify as Qualified Improvement Property (QIP) and get a 15-year recovery period.1Office of the Law Revision Counsel. 26 U.S. Code 168 – Accelerated Cost Recovery System That 24-year gap can shift hundreds of thousands of dollars in deductions forward.
QIP covers interior improvements to a nonresidential building made after the building was first placed in service. It does not include building enlargements, elevators, escalators, or work on the internal structural framework. The focus is the interior fit-out: walls, flooring, ceilings, lighting, plumbing fixtures, and similar work.
Who Deducts the Improvement
The party the tax code treats as the owner is the one who depreciates. If the tenant pays for the work directly, the tenant depreciates it. If the landlord funds the improvements through an allowance and retains ownership under the lease, the landlord takes the depreciation.2Office of the Law Revision Counsel. 26 U.S. Code 168 – Accelerated Cost Recovery System – Section: Treatment of Leasehold Improvements That allocation shapes the after-tax cost for both sides and often drives how the allowance is structured in the first place.
Bonus Depreciation Is Back at 100%
The One Big Beautiful Bill Act, signed into law on July 4, 2025, restored 100% first-year bonus depreciation and made it permanent. For qualified property acquired and placed in service after January 19, 2025, the full cost can be deducted in year one, with no scheduled reduction or expiration.3Internal Revenue Service. One, Big, Beautiful Bill Provisions For businesses placing QIP in service in 2026, that means the entire cost of qualifying interior work is deductible immediately rather than stretched over 15 years.
Section 179 as an Alternative
Businesses that prefer a different approach, or that don’t qualify for bonus depreciation, can expense QIP under Section 179 up to a dollar cap. For 2025, the cap is $1,250,000 per return, phasing out once total qualifying property placed in service exceeds $3,130,000. Section 179 also covers roofs, HVAC systems, fire protection, and security systems installed in nonresidential buildings — items that don’t fit the QIP definition but can still be expensed here.4Internal Revenue Service. Instructions for Form 4562
When a Construction Allowance Escapes Income Tax
A landlord’s payment to a tenant to fund a build-out looks like taxable income to the tenant. Section 110 of the Internal Revenue Code provides a safe harbor that excludes a qualified construction allowance from the tenant’s gross income, but the conditions are narrow.5Office of the Law Revision Counsel. 26 USC 110 – Qualified Lessee Construction Allowances for Short-Term Leases The lease must be for retail space where the tenant sells goods or services to the general public. It must be a short-term lease of 15 years or less. The allowance must go toward real property that stays with the building at lease end, not toward removable fixtures or equipment. And the lease must expressly state that purpose.
The exclusion is capped at what the tenant actually spends on qualifying improvements; anything spent on non-qualifying items (furniture, equipment, fixtures the tenant takes when leaving) gets included in income. Both parties must attach a statement to their tax returns for the year the allowance changes hands, identifying the parties, the retail location, the allowance amount, and the portion that qualifies.6eCFR. 26 CFR 1.110-1 – Qualified Lessee Construction Allowances
Non-retail tenants — law firms, accounting practices, back-office operations — cannot use this safe harbor. For those tenants, tax treatment of an allowance depends entirely on how the lease allocates ownership of the improvements.
Writing Off Improvements at Lease End
When a tenant vacates and leaves behind improvements that still carry undepreciated basis, the remaining adjusted basis can be deducted as a loss. The same rule applies to a landlord who made improvements for a tenant and irrevocably disposes of them at lease termination.2Office of the Law Revision Counsel. 26 U.S. Code 168 – Accelerated Cost Recovery System – Section: Treatment of Leasehold Improvements This is one of the more overlooked deductions in commercial real estate; businesses often let old depreciation schedules simply run out without recognizing the loss.
For an abandonment loss, the taxpayer must intend to permanently give up the improvement, not just stop using it temporarily.7eCFR. 26 CFR 1.168(i)-8 – Dispositions of MACRS Property Walking away from a built-out space at lease expiration and surrendering it generally satisfies the requirement.
A related situation shows up mid-lease when a component is replaced, like ripping out old flooring to install new. The remaining basis of the old flooring doesn’t automatically produce a deductible loss. The taxpayer must file a partial disposition election on the return for the year of the replacement. Without it, the old cost sits on the depreciation schedule alongside the new, and no loss gets recognized for the retired component. Missing this election is common in multi-phase build-outs where components are swapped well before the depreciation clock runs out.
Amortizing Lease Acquisition Costs
The cost of getting a lease in place — brokerage commissions, legal fees, and similar expenses — is amortized over the lease term under Section 178 of the Internal Revenue Code.8Office of the Law Revision Counsel. 26 USC 178 – Amortization of Cost of Acquiring a Lease
There’s a trap involving renewal options. If less than 75% of the acquisition cost is attributable to the remaining initial lease term at the time of acquisition, the amortization period must include all renewal options and any other period the parties reasonably expect the lease to continue. In practical terms, a large commission paid to take over someone else’s lease with only a few years left but long renewal options must be stretched over the combined period. The rule prevents front-loading big deductions on short remaining terms when the tenant clearly plans to stay longer.
Building the Amortization Schedule
Whether the schedule is for a tenant improvement surcharge, a CAM pass-through, or a tax depreciation calculation, the inputs are the same: total project cost, interest rate (where one applies), and amortization period.
Total project cost should capture both hard costs (construction labor, materials, demolition) and soft costs (architect and engineering fees, permits, project management). Final construction bids or completed payment applications are the usual sources. The interest rate reflects the landlord’s cost of capital plus a negotiated margin and applies when the allowance is repaid through rent. The amortization period is either the lease term (for tenant improvement allowances) or the asset’s useful life (for capital improvements and tax depreciation).
With those inputs, a standard loan amortization formula produces the payment. A $150,000 build-out at 8% interest over a 120-month lease works out to roughly $1,820 per month. Each payment splits between principal and interest, with interest heavier early and declining over time. Both parties should keep the full schedule in the lease file. Landlords need it to track cost recovery; tenants need it to verify that any early-termination buyout matches the actual remaining balance rather than an inflated figure.