What Are Leasehold Improvements? A Complete Guide
When businesses rent a commercial property, they often need to customize the space to meet their specific operational needs. This may involve installing partitions, upgrading lighting, or adding built-in shelves. These modifications are called leasehold improvements.
But how do these improvements affect accounting, depreciation, and business finances? And what happens to them when the lease expires?
In this comprehensive guide, we’ll break down what leasehold improvements are, provide examples, explain accounting rules, and cover everything businesses need to know.
What Are Leasehold Improvements? Example & Meaning
A leasehold improvement refers to any permanent renovation, modification, or upgrade made to a rented commercial property to fit the tenant’s business needs. These improvements generally stay with the property after the lease ends unless otherwise stated in the lease agreement.
Common Examples of Leasehold Improvements
✅ Installing new flooring (carpet, hardwood, tiles)
✅ Adding walls or partitions for offices
✅ Upgrading lighting or electrical wiring
✅ Installing built-in shelves or cabinets
✅ Painting walls to match branding
Real-Life Example of Leasehold Improvements
Imagine Sarah, a bakery owner, rents a commercial space. To make it functional, she installs commercial ovens, new flooring, and built-in display shelves. These changes become leasehold improvements because they are permanently attached to the property.
Leasehold Improvements Accounting: How They Are Recorded
When a tenant or landlord pays for leasehold improvements, they must record them correctly in financial statements.
Who Records Leasehold Improvements?
- If the tenant pays, the improvement is recorded as an asset on the tenant’s balance sheet.
- If the landlord pays, the improvement remains the landlord’s property.
How Leasehold Improvements Are Categorized
✔️ Capitalized Asset – If the improvement adds value and is permanent, it must be capitalized and depreciated.
❌ Expense – If the improvement is minor, like repainting, it can be recorded as a business expense.
Leasehold Improvements Depreciation & Lifespan
What Is the Leasehold Improvements Depreciation Life?
The IRS and accounting rules state that leasehold improvements should be depreciated over 15 years or the remaining lease term, whichever is shorter.
💡 Example: If a business installs glass partitions and the lease has 5 years left, the improvement must be depreciated over 5 years, not 15.
Methods of Depreciation
There are two main ways to depreciate leasehold improvements:
1️⃣ Straight-Line Depreciation – The improvement loses an equal amount of value every year.
2️⃣ Accelerated Depreciation – More depreciation is applied in the early years for tax benefits.
Leasehold Improvement: Asset or Expense?
Businesses often wonder whether leasehold improvements should be recorded as an asset or an expense.
When Leasehold Improvements Are an Asset
✔️ If they increase the property’s value
✔️ If they are permanent fixtures
✔️ If they cost a significant amount (above $5,000)
When Leasehold Improvements Are an Expense
❌ If they are minor modifications
❌ If they are temporary or movable
❌ If they cost less than the business’s capitalization threshold
Leasehold Improvements Accounting Standards: GAAP vs. IFRS
Different accounting frameworks have unique rules for leasehold improvements.
1. GAAP (Generally Accepted Accounting Principles)
- Leasehold improvements must be capitalized and amortized over the lease term or useful life, whichever is shorter.
2. IFRS (International Financial Reporting Standards)
- Under IFRS 16, leasehold improvements are classified as Right-of-Use Assets and must be depreciated over the lease period.
If you’re familiar with how systems and processes work, understanding how leasehold improvements are treated in accounting is similar to the importance of understanding the financial implications in supply chain management, as discussed in our blog, How Does Fast Fashion Supply Chain Work.
What Happens to Leasehold Improvements When Lease Expires?
When a lease ends, what happens to leasehold improvements depends on the lease agreement.
Possible Scenarios
1️⃣ The Landlord Keeps the Improvements (Most Common)
2️⃣ The Tenant Must Restore the Property to its original state
3️⃣ The Tenant Negotiates a Buyout from the landlord
💡 Tip: Always review your lease agreement to understand what happens at the lease’s end.
What Are Leasehold Improvements on a Balance Sheet?
Since leasehold improvements are considered assets, they appear on a company’s balance sheet under Property, Plant, and Equipment (PP&E).
Example Balance Sheet Entry
| Account Name | Amount ($) |
|---|---|
| Leasehold Improvements | $50,000 |
| Accumulated Depreciation | ($10,000) |
| Net Book Value | $40,000 |
Final Thoughts: Are Leasehold Improvements Worth It?
Investing in leasehold improvements can boost business operations, enhance customer experience, and increase employee productivity. However, businesses must carefully consider:
✔️ Who pays for the improvements?
✔️ How will they be recorded?
✔️ What happens when the lease ends?
What’s Next?
📌 Have you invested in leasehold improvements? Share your experience in the comments below!
Frequently Asked Questions (FAQs):
What are improvements to leasehold property?
Improvements to leasehold property refer to any modifications, upgrades, or renovations made to a rented commercial space to meet the tenant’s needs. These improvements are typically permanent and cannot be easily removed without causing damage to the property.
Examples of leasehold property improvements include:
✔️ Installing new flooring (carpet, hardwood, tiles)
✔️ Upgrading electrical wiring or lighting systems
✔️ Adding partitions or office walls
✔️ Installing built-in shelving or cabinetry
✔️ Upgrading plumbing for sinks or restrooms
These improvements benefit the tenant’s operations but generally become the landlord’s property once the lease ends unless otherwise agreed upon.
What costs can be capitalized as leasehold improvements?
To qualify for capitalization, leasehold improvements must meet specific accounting criteria and have a long-term benefit to the rented property.
Costs that can be capitalized as leasehold improvements include:
✅ Structural Modifications – Building interior walls, partitions, and office cubicles.
✅ Electrical and Plumbing Upgrades – Installing additional outlets, upgrading HVAC systems, or modifying restrooms.
✅ Flooring and Ceiling Improvements – Laying down new carpet, tile, or upgrading ceiling tiles.
✅ Built-In Fixtures – Installing built-in shelves, permanent counters, or reception desks.
✅ Security Enhancements – Installing surveillance cameras or advanced door access systems.
Non-Capitalizable Costs (Expense Instead):
❌ Routine maintenance (painting, minor repairs)
❌ Movable office furniture
❌ Temporary partitions or decorations
Capitalized improvements are recorded as an asset on the balance sheet and depreciated over time instead of being expensed in a single year.
What is the definition of leasehold improvements in IFRS?
Under IFRS (International Financial Reporting Standards), leasehold improvements are classified as Right-of-Use (ROU) Assets and must be accounted for separately from the lease itself.
According to IFRS 16, leasehold improvements must meet the following criteria:
✔️ They must be permanently attached to the leased property.
✔️ They must provide long-term benefits to the tenant.
✔️ They must be depreciated over the shorter of the useful life or lease term.
Unlike GAAP, which allows businesses to capitalize and depreciate leasehold improvements independently, IFRS requires leasehold improvements to be part of the ROU asset calculation.
💡 Tip: Businesses following IFRS must carefully review lease terms and depreciation schedules to comply with international accounting standards.
What happens to leasehold improvements?
The fate of leasehold improvements depends on the lease agreement and the negotiations between tenant and landlord.
Here are the most common scenarios:
1️⃣ The Landlord Retains the Improvements (Most Common)
The improvements become the property of the landlord when the lease ends.
The tenant cannot claim reimbursement unless previously negotiated.
2️⃣ The Tenant Must Remove the Improvements
Some leases require tenants to restore the property to its original condition.
The tenant bears the cost of removal and restoration.
3️⃣ The Tenant Sells the Improvements to the Next Occupant
If a new tenant is moving in, they may buy the leasehold improvements from the previous tenant.
This allows the seller to recover some of the investment.
4️⃣ The Tenant Negotiates a Buyout from the Landlord
In some cases, the tenant can negotiate compensation from the landlord for improvements that add value to the property.
💡 Best Practice: Always check the lease agreement before making significant leasehold improvements to avoid unexpected removal costs at the lease’s end.
