Can Leasehold Improvements Qualify for Section 179?

Yes. Leasehold improvements can qualify for Section 179 expensing, and for most tenants renovating commercial space, the bulk of the work will qualify. For 2026, a business can immediately deduct up to $2,560,000 of eligible improvement costs in the year the space is placed in service, rather than depreciating those costs over 39 years. Combined with 100% bonus depreciation, which the One Big Beautiful Bill Act permanently restored for property acquired after January 19, 2025, most build-outs can be written off in full the year they open.¹

Which Improvements Qualify

Two separate categories of improvements to nonresidential real property are eligible under Section 179.

The first is qualified improvement property, or QIP. This is interior work done to an existing nonresidential building after that building is already in service. For a typical office, retail, or warehouse build-out, QIP covers new drywall, dropped ceilings, interior doors, updated electrical wiring, plumbing, and finishes.²

The second is a set of four building-system categories that Section 179 treats as qualified real property, whether or not the work is purely interior:³

Roofs, including full replacements and structural upgrades.
Heating, ventilation, and air-conditioning systems.
Fire protection and alarm systems, including sprinklers.
Security systems, including surveillance and access control.

A tenant who installs a new HVAC system or replaces a roof on a leased building can expense the cost under Section 179 without meeting the QIP interior test. The building just needs to have been placed in service before the improvement.

What Doesn’t Qualify

Three types of work are carved out of QIP even when they happen inside the building: any construction that enlarges the building’s footprint, elevators and escalators, and work on the internal structural framework such as load-bearing walls and columns. Costs in these categories fall back to the 39-year depreciation schedule for nonresidential real property, which is a long timeline for a tenant on a five- or ten-year lease. Classifying each line item carefully at the outset is worth the effort.²

Eligibility Requirements

Section 179 has a handful of conditions beyond the property-type test:³

The property must be acquired by purchase for use in the active conduct of a trade or business. Property held for investment income doesn’t qualify.
The property must be placed in service during the tax year. For a build-out, that generally means the date the finished space is ready for business operations.
New and used property both qualify, as long as your business is newly acquiring it. Improvements you already owned, or received by gift or inheritance, don’t count.⁴
Purchases from related parties are excluded. Related parties include a spouse, ancestors, and lineal descendants, along with entities where the same person holds more than 50% ownership.⁴

Section 179 is not automatic. You elect it on your return for the year the property is placed in service. The election can later be revoked for any property, but the revocation is itself irrevocable. Miss the election on a timely filed return and you lose Section 179 for that year’s property.

2026 Dollar Limit and Phase-Out

The 2026 dollar limit is $2,560,000. That is the maximum total cost you can expense across all qualifying property placed in service during the year, not just leasehold improvements.³

The investment phase-out begins at $4,090,000. Once total qualifying property placed in service during the year exceeds that threshold, the $2,560,000 cap shrinks dollar for dollar. At $6,650,000 of qualifying property, the deduction disappears entirely. A business placing $5 million of qualifying property in service, for example, would see its cap reduced to $1,650,000: the $2,560,000 starting amount minus the $910,000 by which purchases exceeded $4,090,000.

Both thresholds are indexed for inflation going forward. The base figures of $2,500,000 and $4,000,000 were set by the One Big Beautiful Bill Act for property placed in service after December 31, 2024, with inflation adjustments starting for tax years after 2025.

The Taxable Income Ceiling

Even under the dollar cap, the Section 179 deduction cannot exceed your aggregate taxable income from all active trades or businesses for the year. The deduction can’t create or increase a net operating loss.⁵

What counts as active business income is broader than many taxpayers expect. For individuals, wages and salary from employment are included, because the IRS treats employees as actively conducting the trade or business of their employer. Section 1231 gains and interest earned on working capital count too. Passive investment income and portfolio income generally do not.

Any Section 179 deduction that exceeds your qualifying taxable income isn’t lost. It carries forward indefinitely and can be used against qualifying income in later years. For a business that had a weak year, though, the income ceiling can delay the benefit. That timing risk is one reason some businesses lean on bonus depreciation instead.

Section 179 or Bonus Depreciation

Bonus depreciation is the other route to writing off leasehold improvements immediately, and after the One Big Beautiful Bill Act it is again a permanent 100% first-year deduction for qualifying property, including QIP.¹

The two tools work differently in ways that matter for planning:

Section 179 is capped at $2,560,000 for 2026 and phases out for larger purchasers. Bonus depreciation has no dollar limit and no phase-out.
Section 179 cannot exceed your active business income. Bonus depreciation can create or increase a net operating loss, which then carries forward.
Section 179 is applied first. Bonus depreciation then applies to whatever basis remains.⁶

A smaller business with strong current-year profits and modest improvement costs is often fine using Section 179 alone. A larger business, or one expecting a loss, will usually prefer bonus depreciation for its flexibility. A taxpayer can also elect out of bonus depreciation entirely when spreading deductions across future years is more useful.

Landlord or Tenant: Who Claims It

Whoever pays for and owns the improvements generally claims the deduction. Ownership for tax purposes turns on who bears the economic benefits and burdens of the property, not just who holds legal title. In most leasehold build-outs, the tenant pays, uses the space, and takes the deduction.

Tenant improvement allowances complicate this. When a landlord provides cash for the tenant to build out improvements the tenant will own and use, that cash is taxable income to the tenant. The tenant then depreciates or expenses under Section 179 the improvements built with those funds. The landlord amortizes the cash allowance as a lease acquisition cost over the lease term.

One exception sits in IRC Section 110. For retail space with a lease term of 15 years or less, where the improvements will revert to the landlord at lease end, the tenant doesn’t recognize income on the allowance, and the landlord depreciates the improvements as nonresidential real property. Misclassifying this can produce unexpected taxable income, so the lease terms should be reviewed before either party files.

Recapture If Things Change

An immediate Section 179 deduction comes with strings. If the property’s business use drops to 50% or below at any point before the end of its recovery period, part of the deduction must be recaptured as ordinary income in the year use declines.⁷

The same treatment applies when you sell or dispose of the property. The prior Section 179 deduction is treated as depreciation for Section 1245 recapture purposes. Any gain on disposition, up to the amount of the Section 179 deduction previously taken, is taxed as ordinary income rather than at capital gains rates. For S corporations and partnerships, the recapture calculation happens at the owner level rather than on the entity return. Recapture is reported on IRS Form 4797. If you abandon or sell a leasehold improvement before the lease expires, expect that form to be part of your filing.

How to Claim It on Your Return

The Section 179 election is made on IRS Form 4562, Depreciation and Amortization, filed with your federal income tax return for the year the improvement is placed in service.⁸

Part I of Form 4562 is where you report the cost of Section 179 property, apply the $2,560,000 dollar limit, calculate any phase-out reduction, and check the taxable income limitation. Any amount blocked by the income limit carries forward on this form for later years. Bonus depreciation on remaining basis or other assets goes in Part II. Because Section 179 reduces the depreciable basis before bonus depreciation is figured, the entries in Part I feed directly into Part II.⁶

The placed-in-service date controls which tax year gets the deduction. For a multi-phase renovation, each phase is placed in service when that portion is ready for use, not when the whole project finishes. Keep contractor invoices, completion dates, and a clear record of what was built.

Check Your State’s Rules

Federal Section 179 and bonus depreciation don’t automatically flow through to your state income tax return. A significant number of states cap Section 179 below the federal limit or decouple from federal bonus depreciation entirely, requiring you to add back the federal deduction and compute state depreciation under older rules. The result can be a real state tax bill even when your federal return shows a large deduction.

Because state conformity varies and changes often, check where your state stands before building cash-flow projections around a full immediate write-off. Your state’s department of revenue site will usually spell out its conformity status.

1
Internal Revenue Service. Treasury and IRS Guidance on Additional First Year Depreciation Deduction
2
Office of the Law Revision Counsel. 26 USC 168 – Accelerated Cost Recovery System
3
Office of the Law Revision Counsel. 26 USC 179 – Election To Expense Certain Depreciable Business Assets
4
Internal Revenue Service. Publication 946, How To Depreciate Property
5
eCFR. 26 CFR 1.179-2 – Limitations on Amount Subject to Section 179 Election
6
Internal Revenue Service. Instructions for Form 4562
7
Internal Revenue Service. Instructions for Form 4797
8
Internal Revenue Service. About Form 4562, Depreciation and Amortization