Do Leasehold Improvements Qualify for Bonus Depreciation? QIP Rules and Rates

Yes, leasehold improvements qualify for bonus depreciation when they meet the tax code’s definition of Qualified Improvement Property (QIP). For QIP acquired after January 19, 2025, the One Big Beautiful Bill Act restored the rate to 100%, meaning the full cost can be deducted in the year the improvement is placed in service.¹ Improvements acquired under a written binding contract signed before that date fall under the old phase-down schedule instead, which drops to 20% for property placed in service in 2026.²

Two things drive the outcome: whether the work counts as QIP in the first place, and when the property was acquired. Get either one wrong and a deduction you were counting on can shift to a 39-year recovery period.

What Qualifies as Qualified Improvement Property

QIP is any improvement a taxpayer makes to the interior of an existing nonresidential building, provided the improvement is placed in service after the building itself was first placed in service.³ The timing point is the one people miss. Interior work done during original construction, before anyone occupies the building, is part of the building’s cost, not QIP.

Three categories of interior work are carved out of the definition and cannot be treated as QIP:

Building enlargements that add square footage.
Elevators and escalators, regardless of location.
Internal structural framework, including load-bearing walls and columns.

Everything else inside the building is generally in bounds: partition walls, dropped ceilings, lighting, flooring, and electrical and plumbing work tied to the tenant’s operations. QIP carries a 15-year MACRS recovery period, which puts it under the 20-year ceiling required for bonus depreciation eligibility.⁴ Nonresidential real property, by contrast, sits at 39 years and never qualifies.

The Current Bonus Depreciation Rate

For qualifying property acquired after January 19, 2025, bonus depreciation is back to 100%.¹ The full cost of QIP placed in service in that window is deductible in year one, subject to the eligibility rules below.

Property acquired under a written binding contract entered into before January 20, 2025, stays on the older Tax Cuts and Jobs Act phase-down: 80% for 2023, 60% for 2024, 40% for 2025, and 20% for 2026.² A build-out contracted in late 2024 but finished in 2026 gets a 20% first-year deduction, not 100%, even though the placed-in-service year is the same.

The IRS has issued interim guidance letting taxpayers rely on existing depreciation rules with the updated rates and dates. Proposed regulations under the new law are expected but not yet final.⁵

Eligibility Details That Often Change the Answer

Placed-in-Service Date

An improvement is placed in service when it is ready and available for its intended use. For a build-out, that generally means when the space is ready to operate, not the date the lease is signed or ground is broken. Certificates of occupancy, contractor completion letters, and inspection sign-offs are the kind of documentation that should live in your permanent records.⁶

New and Used Property

Bonus depreciation applies to both newly constructed improvements and used property you acquire. The catch is that the property cannot have been previously used by you or a related party. Related-party status is defined broadly and reaches family members, corporations with more than 50% common ownership, and partnerships controlled by the same people who control another entity.⁷ This comes up often when a tenant improves a building owned by a landlord with overlapping ownership. If the tenant and landlord are related parties, the QIP is likely ineligible for bonus depreciation.

The Section 163(j) Election

Businesses with average annual gross receipts above the inflation-adjusted threshold face limits on how much business interest they can deduct. For 2025, the threshold is $31 million; the 2026 figure will be slightly higher with inflation adjustments.⁸

Real property businesses can elect out of the interest limitation, but that election moves all nonresidential real property, residential rental property, and QIP onto the Alternative Depreciation System (ADS).⁴ Under ADS, QIP has a 20-year recovery period and is not eligible for bonus depreciation at all. Businesses carrying significant debt should run the numbers both ways before making the election, because the interest deduction gained may be worth less than the accelerated depreciation lost.

Section 179 as an Alternative or Add-On

QIP is also eligible for immediate expensing under Section 179.⁴ For tax years beginning in 2026, the maximum Section 179 deduction is $2,560,000, phasing out dollar-for-dollar once total qualifying property placed in service exceeds $4,090,000.

Section 179 differs from bonus depreciation in a few important ways:

The deduction cannot exceed taxable income from all active trades or businesses. Bonus depreciation can create or increase a net operating loss; Section 179 cannot.
The property must be purchased, not received by gift or inheritance.
Business use of the property must exceed 50% in the year it is placed in service.

Section 179 also covers some real property improvements outside the narrower QIP definition, including roofs, HVAC systems, fire protection, and security systems installed on nonresidential buildings. That makes it useful either as a standalone tool or as a supplement when bonus depreciation is limited by the pre-2025 phase-down.

When Leasehold Improvements Don’t Qualify

Improvements that fail the QIP test, whether because they are structural, enlarge the building, or involve elevators, default to the 39-year recovery period for nonresidential real property under the general depreciation system.² Depreciation is straight-line at roughly 2.5% per year. On a $200,000 structural improvement, that works out to about $5,128 annually, with no bonus depreciation available.

A taxpayer can also voluntarily elect out of bonus depreciation for an entire MACRS asset class by attaching a statement to a timely filed return. The election is irrevocable and applies to every property in the class placed in service during the year. For QIP, electing out does not push the property to 39 years; it stays on the 15-year QIP schedule and depreciates straight-line. This can make sense when a business expects much higher taxable income in later years, has NOL carryforwards that will absorb current income, or faces state tax complications.

State Tax Conformity

A federal bonus depreciation deduction does not always produce a matching state deduction. Many states decouple from federal bonus depreciation entirely or allow only a portion of it, requiring an add-back on the state return and depreciation over the standard recovery period for state purposes. A $1 million federal QIP deduction can produce no current-year state benefit in a decoupled state. Some decoupled states let the disallowed amount be recovered over future years, softening but not eliminating the timing gap. State conformity rules change frequently, and the restoration of 100% bonus depreciation may push additional state responses, so checking your state’s current position before filing is worth the time.

What Happens If the Lease Ends Early

If you abandon improvements at lease termination and they still have undepreciated basis, the tax code treats the property as disposed of, which allows a loss for the remaining adjusted basis.³ The abandonment must be genuine, meaning you walk away with no expectation of recovering value. If the landlord pays you for the build-out through a buyout, that payment reduces or eliminates the loss.

Improvements that were fully deducted in year one through 100% bonus depreciation carry no remaining basis to claim as a loss, which is part of why front-loading the deduction is attractive when the improvement qualifies.

1
Internal Revenue Service. One, Big, Beautiful Bill Provisions
2
Internal Revenue Service. Tax Cuts and Jobs Act: A Comparison for Businesses
3
Office of the Law Revision Counsel. 26 U.S. Code 168 – Accelerated Cost Recovery System
4
Internal Revenue Service. Publication 946 (2025), How To Depreciate Property
5
Internal Revenue Service. Treasury, IRS Issue Guidance on Special Depreciation Allowance for Qualified Production Property
6
Internal Revenue Service. Instructions for Form 4562
7
Office of the Law Revision Counsel. 26 USC 267 – Losses, Expenses, and Interest With Respect to Transactions Between Related Taxpayers
8
Internal Revenue Service. Questions and Answers About the Limitation on the Deduction for Business Interest Expense