A lease commission is capitalized at lease commencement and then expensed in equal monthly amounts over the lease term, so lease commission amortization under ASC 842 means dividing the broker’s fee by the number of months in the lease and recognizing that fixed amount each period. For tax purposes, the same commission is capitalized under IRC Section 178 and amortized on a separate schedule that may or may not match the book period. The two schedules usually differ, and both have to be maintained.
Which Commissions Get Capitalized
ASC 842 treats a commission as an “initial direct cost” only if it is incremental, meaning the cost would not have existed if the lease had not been signed. ASC 842-10-30-9 lists commissions as an example, and ASC 842-10-55-241 illustrates a broker commission being capitalized because it was “incurred only as a direct result of obtaining the lease.”1DART – Deloitte Accounting Research Tool. 6.11 Initial Direct Costs A broker fee earned only when the lease executes is the clearest case and qualifies in full.
Internal employee commissions and bonuses can also qualify, but only if the payment is contingent on the lease being signed. Fixed salaries do not, even for employees who spent weeks negotiating the deal, because the salary would have been paid regardless.1DART – Deloitte Accounting Research Tool. 6.11 Initial Direct Costs
Legal fees usually do not qualify. Costs for negotiating terms, drafting agreements, or evaluating a prospective tenant’s credit are paid whether or not the deal closes, so they are expensed as incurred. Only a true success fee, structured to be paid only on execution, has a chance of meeting the incremental test. General overhead, marketing, administrative salaries, and due diligence costs are also excluded.
When You Can Expense Instead of Amortize
Short leases get a shortcut. Under ASC 340-40-25-4, if the amortization period would be one year or less, the entity can expense the commission in the period paid rather than spreading it across a handful of months. The expedient has to be applied consistently to every qualifying contract, not picked lease by lease.
Calculating the Monthly Amortization
The amortization period runs from the lease commencement date through the end of the lease term, not from the date the commission was paid or the lease was signed. A commission paid three months before the tenant takes possession still starts amortizing on the commencement date.
The lease term includes any renewal options that are “reasonably certain” to be exercised. That is a judgment anchored in the economics of the renewal. A five-year lease with a renewal at well-below-market rent is almost certain to be exercised, so the amortization period becomes ten years. A renewal at above-market rates with nothing holding the tenant to the space is unlikely and would be excluded.
The method is straight-line. Divide the capitalized commission by the number of months in the amortization period and recognize that amount each month. A $48,000 commission on a 96-month lease produces a $500 monthly charge. For operating leases, ASC 842 requires lessees to recognize a single lease cost on a straight-line basis, so initial direct costs folded into the right-of-use asset follow the same pattern.
The Journal Entries
At commencement, the full commission is capitalized. For a $36,000 broker fee on a six-year lease:
- Debit Deferred Lease Commission (asset) $36,000
- Credit Cash or Accounts Payable $36,000
For lessees, the commission is typically rolled into the right-of-use asset rather than carried on its own line. For lessors, it usually sits as a deferred commission asset or within other assets.
Each month, a portion moves to the income statement:
- Debit Amortization Expense $500
- Credit Deferred Lease Commission (or Right-of-Use Asset) $500
The expense sits within operating expenses, and the balance sheet shows the remaining unamortized balance declining in a straight line to zero.
When the Lease Is Modified
If a modification extends the term, the remaining unamortized balance is spread prospectively over the new remaining period. Say $20,000 was capitalized on a five-year lease and the tenant extends for three more years after year two. At the modification date, $12,000 is unamortized. That $12,000 is now amortized over the six years left on the modified lease (three remaining original years plus three new years), producing a new monthly charge of roughly $167. The old schedule is discarded from that date forward.2Deloitte. ASC 842-10 Roadmap Leasing Chapter 8 Lessee Accounting 8-6 Lease Modifications
Any new commission paid to secure the extension is a separate initial direct cost. It gets capitalized on its own and amortized over the renewal period, running parallel to the original asset.
When the Lease Ends Early
If a lease terminates before its scheduled end, the remaining commission balance is written off immediately. ASC 842-20-40-1 requires the lessee to derecognize the right-of-use asset and lease liability, with any difference recognized as a gain or loss.3Deloitte. 8.7 Derecognizing a Lease If $10,000 remains unamortized:
- Debit Loss on Lease Termination $10,000
- Credit Deferred Lease Commission $10,000
The entire remaining balance hits the income statement in the termination period. There is no option to spread it.
Partial terminations, where a tenant gives back part of the space, require a proportional write-off. ASC 842 treats this as a modification: a share of the deferred commission corresponding to the surrendered space is written off, and the remainder continues amortizing over the adjusted term for the retained space.3Deloitte. 8.7 Derecognizing a Lease
A capitalized commission is also subject to impairment testing under ASC 360 when something threatens the economic benefit of the lease, such as a major tenant bankruptcy or a decision to sublease at a loss. If the carrying amount of the asset group exceeds the undiscounted future cash flows from the lease, the asset is written down to fair value and the write-down is permanent.
Tax Amortization and the 75% Rule
The IRS does not allow an immediate deduction. Commissions are generally deductible under IRC Section 162, but Section 162 cross-references Section 263, which requires capitalization of costs that produce benefits beyond the current tax year.4eCFR. 26 CFR 1.162-1 – Business Expenses A lease commission plainly creates a multi-year benefit. Treasury Regulation Section 1.263(a)-4 provides the framework and lists leases among the intangibles that must be capitalized.5IRS. Treasury Decision 9107 – Section 1.263(a)-4 Amounts Paid to Acquire or Create Intangibles
IRC Section 178 sets the amortization period for lessees. The default period is the remaining initial lease term. However, if less than 75% of the cost is attributable to the initial term, the amortization period must include all renewal options and any other period the parties reasonably expect the lease to continue.6Office of the Law Revision Counsel. 26 U.S. Code 178 – Amortization of Cost of Acquiring a Lease For a flat-rate lease, the cost attribution tracks the time periods, so the test effectively compares the initial term to the total foreseeable term. A lessee with a five-year initial term and two five-year renewal options may be forced to amortize over the full 15 years if the initial term is less than 75% of the foreseeable total.
When a lease terminates early, the remaining tax basis is generally deductible as a loss under IRC Section 165. To claim an abandonment loss, the taxpayer has to show both an intent to abandon and an affirmative act that irrevocably cuts ties to the asset. Internal decisions or simply not using the space are not enough. The IRS requires an “identifiable event” observable to outsiders, such as formally surrendering the premises to the landlord.7IRS. Rev. Rul. 2004-58
Because the book period includes renewals that are “reasonably certain” while the tax period either stops at the initial term or stretches to the full foreseeable term under the 75% rule, the two schedules rarely match. The difference is a temporary book-tax difference and shows up as a deferred tax asset or liability. Keep parallel amortization schedules for each commission and reconcile them each period.
What to Disclose
Lessees that embed initial direct costs in the right-of-use asset have to identify, in the footnotes, which balance sheet line contains the operating lease asset and which contains the finance lease asset; the two categories cannot be combined. For entities with material deferred commission balances, the footnotes should describe the capitalization policy, the amortization method, and the total amount expensed during the period. The disclosure needs to be specific enough that a reader can see how the entity decided a cost was incremental and how it set the amortization period when renewal options were in play.