Leasehold improvements are renovations made to a rental property usually to increase it’s marketability. These improvements can be done either by the landlord or the tenant of the rental space.
Alterations made by a tenant can be removed at the end of their lease as long as the removal does not damage the property or structure. These types of improvements are an asset to the landlord and can be depreciated over a 15 year period.
The following ARE considered a leasehold improvement:
- Any type of interior partition
- Painting of any kind
- Installing flooring (tile, vinyl, carpet)
- Changing light fixtures
- Bathroom accessories
- Millwork
The following are NOT considered a leasehold improvement:
- General maintenance
- Repairs
- Equipment or furniture NOT attached to the rental property
Leasehold Improvement Depreciation
The IRS does not allow owners of rental properties to write off the cost of leasehold improvements. However, they do allow them to depreciate them over time. How fast and how much a person can depreciate these improvements depends on if they are truly a leasehold improvement or considered a building improvement. The state of the tax code is another factor and is always fluctuating.
A building improvement is seen as a part of the existing building. These types of renovations can be depreciated over the life of the building. In order for an alteration to be considered a leasehold improvement, the work needs to meet these three criteria:
- The renovation/alteration must be completed by the landlord or tenant of the rental space
- These improvements must be contained to the tenants area and must not interfere with other tenants, the building’s lobby or other public areas or the structure of the building
- The building needs to have been in use or occupied with in the last 3 years
If the landlord makes the improvement to the rental, they will get to claim the depreciation deduction. If the tenant makes the upgrades to the space, they would be able to claim it.
Leasehold improvements can be deducted over a 15 year period. So, if a person spends $20,000 on these improvements, they can claim a depreciation deduction allowance of $1,333 each year for the next 15 years. Sometimes people are eligible to claim a bonus depreciation in the first year. This bonus can be up to 50% of the total cost of the improvement up to $250,000. For more on this read about Section 179 deduction in detail. Taking more in the first year will reduce the depreciation for the next 14 years.
If a leasehold improvement gets left behind before it completely depreciates, such as the tenant vacating the premises, whoever made the improvements can write off the value to zero immediately and claim the remainder of the deduction.
As of right now, the current life of the depreciation is 15 years, but it was 39 years prior to 2001 and is expected to change back to 39 years this year. These tax rules can and do fluctuate so it’s important to check and understand the tax code before you decide to make any leasehold improvements.
