Leasehold improvements are permanent or semi-permanent changes a tenant makes to the interior of a rented commercial space, such as interior walls, built-in cabinetry, custom lighting, flooring, or specialized wiring and plumbing. The landlord typically ends up owning them, the tenant typically pays for them and takes the tax deductions, and both sides need to think carefully about funding, depreciation, insurance, and what happens to the work when the lease ends. Most interior improvements to commercial buildings qualify as “qualified improvement property” and depreciate over 15 years, though bonus depreciation or Section 179 expensing can allow a full first-year write-off.
What Qualifies as a Leasehold Improvement
The defining trait is integration. If the modification is physically attached to the interior of the building and can’t be removed without damaging the structure or the improvement itself, it’s a leasehold improvement. Framing out private offices, building a reception desk into the wall, installing drop ceilings, laying new flooring, running specialized electrical circuits — all leasehold improvements.
Trade fixtures are different, and the distinction matters at move-out. A salon chair, a commercial pizza oven, or bolted-on display shelving is equipment the business uses in daily operations. Trade fixtures generally remain the tenant’s personal property and leave with the business. Leasehold improvements stay with the building. Calling something a trade fixture when it’s really a structural improvement can spark a dispute over what you’re allowed to take with you.
Who Owns the Improvements
Once an improvement is permanently attached, legal ownership almost always belongs to the landlord. Even six figures of high-end finishes become part of the real estate. Most commercial leases spell this out explicitly.
The tenant who pays for the work still claims the depreciation deductions, though. This is a long-standing IRS principle: the party bearing the economic cost recovers that cost through depreciation, regardless of who holds title. During the lease, the tenant’s rights to use and modify the improvements come from the lease itself. Most agreements give the tenant full use throughout occupancy and require everything to be handed over at lease end, unless there’s a buyout or removal clause. A tenant who abandons improvements at lease end can recognize a tax loss based on the remaining undepreciated value.
How Tenants Pay for the Build-Out
Most commercial tenants negotiate a tenant improvement allowance, or TIA, as part of the lease. The TIA is a dollar amount the landlord contributes to construction, usually expressed per rentable square foot. A common range runs from $20 to $50 or more per square foot, with larger allowances going to long-term, financially stable tenants and to tenants in markets with high vacancy.
The money moves one of two ways. The landlord reimburses construction invoices up to the cap, or the landlord credits the allowance against the first several months of rent. Either way, the tenant runs the build-out: picking contractors, choosing materials, managing the schedule. The risk that comes with that control is real. Construction costs frequently exceed estimates, and every dollar over the allowance is the tenant’s. Soft costs — architectural fees, permits, project management — are often excluded from the TIA, which catches first-time tenants off guard.
Turnkey Deals
Some landlords deliver a finished space instead of writing a check. In a true turnkey arrangement, the landlord runs construction and absorbs the cost, so the tenant gets cost predictability and skips the project-management headache. The tradeoff is less customization and standardized finishes. Watch out for deals marketed as “turnkey” that actually cap the landlord’s spend at a fixed number; those are capped allowances in disguise, and any overrun still comes out of the tenant’s pocket.
Is the Allowance Taxable to the Tenant?
A TIA can be treated as taxable income to the tenant, which would eat into its value. Section 110 of the tax code provides a safe harbor letting qualifying tenants exclude the allowance from gross income, but the criteria are narrower than many business owners realize. All three conditions have to be met:
- The tenant uses the space to sell goods or services to the general public. This covers more than storefronts — doctors’ offices, hair salons, insurance agencies, and bank branches all qualify.
- The lease term is 15 years or less.
- The lease expressly states the allowance is for constructing or improving the property, and the improvements revert to the landlord at lease end.
The exclusion applies only to the portion actually spent on qualifying improvements. Receive $100,000, spend $80,000 on construction, and the remaining $20,000 is taxable income. Tenants who don’t fit the safe harbor, such as office tenants on leases longer than 15 years, should work with a tax advisor. In many cases the allowance is treated as a lease incentive recognized over the lease term rather than as a lump-sum income event, but the analysis is fact-specific.
Depreciation and Tax Deductions
Leasehold improvement costs must be capitalized and recovered over time. You cannot deduct the full cost as an expense in the year you pay for the work, regardless of the dollar amount.
The 15-Year Recovery Period
For federal income tax purposes, most interior improvements to nonresidential buildings qualify as qualified improvement property (QIP) and depreciate over 15 years under the Modified Accelerated Cost Recovery System.1Office of the Law Revision Counsel. 26 U.S. Code 168 – Depreciation The 15-year period is fixed by the tax code and does not shorten to match a shorter lease. Even on a 7-year lease, tax depreciation still runs 15 years.
QIP covers improvements to the interior of a nonresidential building placed in service after the building was originally put into use. It excludes building enlargements, elevators and escalators, and changes to the building’s internal structural framework.2Legal Information Institute (LII) / Cornell Law School. 26 USC 168(e)(6) – Qualified Improvement Property If your renovation touches any of the excluded items, keep separate accounting so the qualifying interior work isn’t tainted by non-qualifying structural or expansion costs.
Bonus Depreciation
Bonus depreciation lets a business deduct a large percentage of QIP costs in the first year the improvement is placed in service, rather than spreading them over 15 years. Under the Tax Cuts and Jobs Act’s original schedule, bonus depreciation was phasing down from 100% to zero between 2023 and 2027. Legislation passed in 2025 restored 100% bonus depreciation, so eligible businesses can write off the full cost of qualifying improvements in year one. That immediate deduction can substantially cut the after-tax cost of a build-out.
Section 179 Expensing
Section 179 is another route to a first-year deduction. QIP is eligible, and for 2026 the deduction limit is $2,560,000 in qualifying property costs, phasing out dollar-for-dollar once total qualifying property exceeds $4,090,000.3Internal Revenue Service. Topic No. 704, Depreciation It’s especially useful for smaller build-outs sitting well inside the limit. Unlike bonus depreciation, Section 179 requires enough taxable income to absorb the deduction that year.
Precise record-keeping matters here. Keep QIP costs cleanly separated from excluded items like framework modifications or expansions. Misclassifying expenses can lose you deductions worth thousands and invite an audit. If the job mixes interior finishes and structural work, ask your contractor to break out costs by category on every invoice.
The Insurance Gap That Catches Tenants
Standard commercial property insurance often does not automatically cover leasehold improvements. Coverage for “betterments and improvements” may require a separate endorsement or explicit addition to the policy. Spend $200,000 on a build-out, have a fire destroy the space, and discovering that gap after the loss is devastating.
Your lease decides who’s responsible for repairing or replacing improvements after a casualty. If the lease puts that on the landlord, the landlord’s building policy should cover it. If the lease is silent or puts repair on you, which is common, you need your own coverage for the full replacement value of the improvements. Many landlords explicitly refuse to bump up their building insurance to reflect the added value of tenant improvements, so the gap falls on the tenant to close. Review both documents before construction starts, not after.
During construction itself, a builder’s risk policy protects materials and partially completed work. It needs to be in place before materials show up on site. The lease usually says who buys it; often that’s the tenant.
Restoration When the Lease Ends
Commercial leases frequently include surrender clauses requiring the tenant to return the space to its original shell condition. That means tearing out interior walls, ripping up custom flooring, pulling specialized wiring, and hauling away the debris, all on the tenant’s dime. Commercial interior demolition typically runs $4 to $15 or more per square foot depending on the size and complexity of the space, and larger or more elaborate build-outs push higher.
Missing the restoration deadline can cost you the security deposit and expose you to a lawsuit for the full cost of restoration plus damages for the time the space sits unusable. The better move is to negotiate restoration terms before construction begins. Some landlords will agree in writing that certain improvements can stay, especially upgrades that help the next tenant, like modern electrical or updated HVAC. Get that agreement in writing before you spend the money, not five or ten years later when the lease expires.
If restoration is going to fall on you, put demolition costs into the original project budget. Tenants who plan for it treat it as an inevitable project cost rather than a shock that lands right when they’re also paying to set up a new location.
ADA Compliance Is Triggered by the Renovation
One boundary worth flagging: any alteration to a commercial space open to the public triggers Americans with Disabilities Act requirements. Altered portions of the facility must be made accessible to the maximum extent feasible.4U.S. Department of Justice ADA.gov. Americans with Disabilities Act Title III Regulations
The rule most tenants don’t see coming is the “path of travel” requirement. When your renovation affects a primary function area — a customer lobby, dining room, or sales floor — you may also need to make the path of travel accessible, including entrances, corridors, restrooms, and drinking fountains that serve the altered space. The obligation is capped at 20% of the total renovation budget, with priority to an accessible entrance first, then an accessible route, then restrooms.4U.S. Department of Justice ADA.gov. Americans with Disabilities Act Title III Regulations Purely back-of-house work (boiler rooms, storage, break rooms) doesn’t trigger the rule, and minor changes like signage or outlets don’t either. If you’re rebuilding a customer-facing space, plan on at least 20% of the renovation cost potentially going to accessibility. Skipping it isn’t just a legal problem; most municipalities won’t issue final permits without it.