Improvements Made By The Tenant In A Commercial Lease

Tenant Improvements in a Commercial Lease: When landlords negotiate lease contracts for properties, they frequently include a provision for the tenant to enhance the property. Large allowances frequently assist landlords in securing longer-term leases that benefit both parties throughout the rental duration.


However, like with all areas of property leasing management, if not handled correctly, these allowances can pose problems with accounting and establishing compliance with accounting rules. This article will address all of the often asked issues regarding tenant improvement allowances and how to account for them.


What Are Leasehold and Tenant Improvements?


The renovations or customizations made to a property to benefit the tenant are referred to as leasehold improvements or tenant improvements. The change must contain the following features to be considered a tenant improvement:


  • The modifications are performed on leased assets. Building upgrades, therefore, apply if they are made in the rental space (e.g., the office), but not if they are built outside of that space (e.g. Communal areas such as elevators, stairs, etc).
  • Unless it is understood that the expenses are the landlord’s responsibility, the renter must pay for the improvements. In that instance, the landlord will keep track of the expenses in their own books.
  • Renter improvements should be long-lasting and benefit the tenant or future tenants for at least a year.
  • The improvement cannot be separated from the leased land.
  • The landlord reclaims the improvement at the conclusion of the lease.


What is The Method of Payment for the Tenant Improvement Allowance?

The tenant improvement allowance is typically offered as compensation for the costs incurred by the tenant in making necessary changes/renovations to the rented premises. This means that the tenant must pay the expenses out of his own pocket first, and the landlord will refund him later. The refund might be granted as a flat sum immediately after the refurbishment is completed, or it can be spread out throughout the lease term.


When is the Tenant Improvement Allowance Agreed Upon?

Although the tenant improvement allowance is granted to the tenant after the renovation is completed, the amount of the allowance is determined when the lease agreement is negotiated. Before requesting the landlord for the allowance, the renter should have a good sense of how much the refurbishment is going to cost. To lease out the premises, a landlord that is keen to lease out the space may be willing to provide a higher tenant improvement allowance.


What types of improvements are eligible for the tenant improvement allowance?

Landlords allow tenants to request a tenant improvement allowance to cover both the hard and soft costs of any renovations to the rented premises. Hard expenses are changes to the property made by the tenant that benefits the landlord. New flooring, electrics, HVAC, windows, framing, and doors are examples of hard costs. Management fees are examples of soft costs.


What is Not Eligible For the Tenant Improvement Allowance?

The tenant improvement allowance does not cover any projects or expenses incurred as a result of the following:


  • Improvements tailored to the tenant’s specific requirements
  • Improvements that do not add value to the landlord’s property
  • Modifications that are removable (e.g. Internet-related equipment, furniture, and cabling)
  • Structure enhancements are changes made outside of the rental space that benefit the overall building (e.g. Repaving outdoor walkways, upgrading elevators, replacing roofs, renovating lobbies)


What is the Average Tenant Improvement Allowance?

A tenant improvement allowance’s size varies depending on the amount of work required and the individual remodelling plans. Some features may require very little work, while others may necessitate a total overhaul. Without a thorough remodelling plan, the allocation can be as low as $10-20 per square foot, which is unlikely to be sufficient money for new offices or commercial units.


Landlords determine the exact allowance, with tenants covering any desired modifications that exceed the budget. Typically, they will settle on a price by evaluating the real estate market, client value, and the added worth of the suggested repairs. Landlords, for example, may be ready to provide a higher allowance to businesses transforming a warehouse into a modern workspace.


Turn-Key Agreement


A turn-key arrangement, also known as a turn-key build-out, happens when the landlord solely supervises the construction of tenant improvements and delivers the finished area to the tenant. Turn-key agreements shield the landlord against budget overruns by incorporating contingency charges.


Landlords determine the exact allowance, with tenants covering any desired modifications that exceed the budget. Typically, they will settle on a price by evaluating the real estate market, client value, and the added worth of the suggested repairs. Landlords, for example, may be ready to provide a higher allowance to businesses transforming a warehouse into a modern workspace.


Tenant improvement allowance amortized

An “amortized tenant improvement allowance” is created when the tenant improvement allowance is combined with a loan from the landlord. Amortization is a method of accounting that reduces the book value of a loan or intangible asset over a predetermined period of time. The amortization is often repaid in instalments during the lease term, usually with interest.


Accounting experts advise that if the entire expenses made for tenant improvements during the same period exceed the tenant’s capitalization limit, the whole should be capitalized and amortized over the lease term or the life of the improvements. Nonetheless, this is something that is negotiated and agreed to on a case-by-case basis by both parties.


Are Tenant Improvements Deductible for Tax Purposes?

No. However, because tenant renovations are considered part of the building, landlords can account for depreciation. The depreciation deduction is available to whoever controls the improvements, whether the renter or landlord.


Who is Responsible for Tenant Improvements?

Typically, the landlord will own the tenant improvements. Even if the tenant funds and manages the renovations, this does not guarantee that the changes will be theirs.


While payment for tenant upgrades is normally discussed, ownership is usually determined by the lease agreement. Almost all commercial net leases indicate that upon completion, the tenant improvements become the landlord’s assets.


How are Tenant Improvement Allowances Accounted For?

Accounting for tenant improvement allowances is dependent on whether the upgrades are funded, overseen, and owned by the landlord or the tenant. The table below provides a quick overview of how to account for these allowances depending on whether the landlord or the renter owns the improvements.


Accounting for Tenant Improvements if the Landlord Owns the Improvements

When the landlord owns the renovations, they must report the tenant improvements as fixed assets and account for their decreasing worth over a certain period. The useful life of the renovation or the term of the lease, whichever is shorter, is the depreciation period for tenant improvements.


For example, if carpeting is put with the expectation of being replaced in five years and the remaining lease term is seven years, the depreciation period should be only five years. If the lease term is two years rather than seven, the depreciation period should be two years because it is shorter than the useful life of the new carpeting.


In some circumstances, the tenant may have a high expectation of renewing the lease and will agree to extend the depreciation period to cover the additional term of the lease, subject to a cap on the asset’s useful life.


When a new tenant moves in during the time in which the asset’s depreciation is being accounted for, the landlord can continue to account for the prior depreciation schedule as long as they do not require any further upgrades. If the item is destroyed or damaged, the remaining balance is reflected as a loss on the income statement.


Accounting for Tenant Improvements if the Tenant Owns the Improvements

When the tenant owns the improvements, the TIA should be recorded as a tenant inducement, treated as a capital expenditure, and amortized over the rental term. Because the landlord will take over any remaining assets, salvage value is not included in the depreciation computation. If the renting period is too short, the tenant must write off the remaining debt.


How are Tenant Improvement Allowances Tracked?

Tenant lease improvements are considered assets, and they must be tracked. Keeping track of TIAs and ensuring they’re properly accounted for might quickly become hard if you have many properties. For commercial premises where renovations are costly, visibility and tracking of improvements are critical. Failure to properly record and depreciate these values might be harmful to the health of your firm.


Rather than worrying about manually keeping track of all these numbers, it is best to invest in property lease management software. With purpose-built software, your team will be able to ensure full visibility of all funds as well as the ability to track and depreciate the value of assets over time without having to worry about data-entry errors or administrative bottlenecks.




What Are Some Leasehold Improvements?

In commercial buildings, leasehold improvements generally benefit one tenant. As part of the renovation, you’ll need to paint, install new walls, hang shelves, change flooring and lighting, and add offices, walls, and partitions.


Is it possible to deduct leasehold improvements from your taxes?

Leasehold improvements are not deductible. However, because any modifications made are regarded to be part of the property, the IRS allows building owners to account for their depreciation.


Who Is Responsible for Leasehold Improvements?

Landlords budget for and pay for renovations by providing a tenant improvement allowance or by reducing rent. They could potentially pay by providing the tenant with a package of alterations from which to choose. Normally, the tenant is responsible for any additional costs that exceed the budget.

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