Who Depreciates Tenant Improvements, the Landlord or the Tenant?

TL;DR: Whoever pays for the work is generally the one who depreciates it. Landlord pays, landlord depreciates. Tenant pays, tenant depreciates. What almost nobody gets right is the schedule: the lease term does not set it. A seven-year lease does not mean a seven-year write-off. Interior work on a commercial building usually lands in qualified improvement property, which Congress put in the 15-year class, and 15-year property is eligible for 100 percent bonus depreciation again for anything acquired and placed in service after January 19, 2025. Classify the same buildout as part of the building instead and it crawls out over 39 years.

Key Takeaways

• The party that bears the cost of the improvement is generally the party that depreciates it, regardless of who holds title to the building.
• Section 168(i)(8) settles the schedule question: improvements on leased property are depreciated under the regular rules, using the property's own recovery period. The lease term is not a depreciation period.
• Qualified improvement property has a 15-year recovery period under section 168(e)(3)(E)(vii). Nonresidential real property takes 39 years. Same dollars, same walls, nearly a 25-year spread.
• Because 15 years sits under the 20-year ceiling, qualified improvement property is bonus-eligible. For a buildout where construction started after January 19, 2025, that bonus is 100 percent.
• Qualified improvement property has to be interior and it has to be a commercial building. Enlargements, elevators, escalators and the internal structural framework are carved out by statute.
• Residential rental buildouts do not qualify. The statute says nonresidential, and it means it.
• A construction allowance under section 110 flips the answer: the tenant leaves the money out of income and the landlord is treated as the owner of the finished work.

Who gets the deduction, the landlord or the tenant?

Follow the money. The party that actually bears the capital cost of the improvement is the party that gets to depreciate it. If the landlord funds a buildout and keeps it on their books, the landlord depreciates it. If the tenant writes the checks for its own fit-out, the tenant depreciates it, even though the landlord owns the bricks and will still own them after the tenant is gone.

That last part is where the confusion starts. Tenants hear that they do not own the building and conclude they cannot own a depreciable asset. They can. The improvement is a separate asset from the building, and the tenant's investment in it is a real basis that gets recovered over time.

The determination is not always as clean as "who signed the invoice," though. It turns on who holds the benefits and burdens of the finished work, and a lease can be drafted to put that in either place. A tenant allowance that the landlord controls and capitalizes sits differently from a cash contribution the tenant spends however it likes. This is the one piece of a buildout worth having your CPA read the lease on before anyone depreciates anything, because both parties claiming the same improvement is a problem that surfaces years later, usually in an exam.

Why doesn't the lease term set the depreciation schedule?

Because the law stopped working that way decades ago, and a lot of software, spreadsheets and lease accountants never caught up.

Here is the operative sentence, from 26 U.S.C. section 168(i)(8)(A): "In the case of any building erected (or improvements made) on leased property, if such building or improvement is property to which this section applies, the depreciation deduction shall be determined under the provisions of this section."

Read what that does. It sends you to the regular depreciation rules, which assign a recovery period based on what the asset is. It does not send you to the lease. So a tenant with a five-year lease who spends $300,000 on a fit-out does not get to recover $60,000 a year for five years. The tenant recovers it on whatever schedule the asset class dictates, and that schedule may well run longer than the tenant's occupancy.

Book accounting is the reason this myth has such a long life. For financial statements, leasehold improvements are commonly amortized over the shorter of the lease term or the useful life. That is a book convention. It has nothing to do with the tax return, and treating the two as the same number is one of the more expensive bookkeeping habits in commercial real estate.

What is qualified improvement property, and why does it decide the whole answer?

Once you know who depreciates, the only question left is how fast, and that comes down to classification.

Section 168(e)(6)(A) defines qualified improvement property as "any improvement made by the taxpayer to an interior portion of a building" that is nonresidential real property, as long as the improvement is placed in service after the building was first placed in service. Section 168(e)(3)(E)(vii) then puts "any qualified improvement property" in the 15-year class. Nonresidential real property, under section 168(c), takes 39 years.

Four conditions are doing real work in that definition, and a buildout can fail any one of them:

• Interior. A new storefront facade, a roof, a parking expansion: none of that is interior, so none of it is qualified improvement property.
• Nonresidential. Apartment and residential rental buildouts are out. The category simply does not reach them.
• After the building opened. Original construction is part of the building. The improvement has to come later.
• Not one of the carve-outs. Section 168(e)(6)(B) excludes any expenditure attributable to "the enlargement of the building," "any elevator or escalator," or "the internal structural framework of the building."

Notice what is not on that list: a lease. Qualified improvement property does not require one. An owner-occupant renovating their own space gets the same 15-year treatment a tenant does. Lease or no lease, the test is about the physical work, not the paperwork around it.

Can you take 100 percent bonus depreciation on a tenant buildout?

Usually yes, and this is the part worth getting right, because the timing rule is specific enough to change the answer by hundreds of thousands of dollars.

Bonus depreciation reaches property with a recovery period of 20 years or less. Qualified improvement property is 15-year property. So it qualifies, and the only question is the percentage.

IRS Publication 946 (2025), for use in preparing 2025 returns, states that Public Law 119-21 "reinstated the 100% special depreciation allowance for certain qualified property" acquired and placed in service after January 19, 2025. Property acquired before that date but placed in service afterward is treated differently: Publication 946 limits the allowance to 40 percent for certain qualified property acquired after September 27, 2017 and placed in service after December 31, 2024 and before January 1, 2026.

Both halves of that test have to land on the right side of January 19, 2025. Which raises the question nobody asks until it is too late: when is a buildout "acquired"? You are not buying it off a shelf. You are building it.

IRS Notice 2026-11, the interim guidance on section 168(k) as amended by Public Law 119-21, answers this for self-constructed property. Manufacture or construction generally begins when physical work of a significant nature starts, and the notice carries a safe harbor treating that as the point where more than 10 percent of the total cost, excluding land and preliminary activities like planning and permitting, has been paid or incurred. For a buildout that broke ground well after January 2025, you are in 100 percent territory. For one that was already substantially underway before then, you may not be, and that is a conversation to have before the return is filed rather than after.

One more thing on bonus: it is not an all-or-nothing good. A full write-off in a year with little income can strand the deduction behind the loss limitation rules. I went through the case for turning it off deliberately in the post on electing out of bonus depreciation.

What if the landlord just writes the tenant a check?

Then a different section takes over, and it moves the deduction.

Section 110 covers what it calls a qualified lessee construction allowance. When a landlord gives a tenant cash to build out retail space under a short-term lease, the tenant leaves that money out of gross income, but only up to what the tenant actually spends on the work. Section 110(a) limits the exclusion to amounts not exceeding "the amount expended by the lessee."

The trade is in subsection (b). The finished work "shall be treated as nonresidential real property of the lessor." The landlord is the owner for tax purposes and takes the depreciation. The tenant got tax-free money and no write-off.

Section 110 is narrower than most people assume, and the limits are in the statute's own definitions. A short-term lease means a lease of retail space "for 15 years or less." Retail space means property used in a business selling tangible personal property or services to the general public. And the improvements have to be qualified long-term real property, meaning property that "reverts to the lessor at the termination of the lease." Office space does not fit. A 20-year ground lease does not fit. Equipment the tenant unbolts and takes with it does not fit.

So before anyone signs, the allowance deserves a hard look from both sides. A landlord who wants the depreciation should want section 110 to apply. A tenant who wants the depreciation should want to fund the work itself and negotiate the economics some other way, through free rent or a lower base rate. Same dollars across the table, very different returns.

What happens to the improvements when the lease ends?

Unrecovered basis does not evaporate because a tenant hands back the keys, and this is the number most lease exits never model.

On the landlord's side the statute is explicit. Section 168(i)(8)(B) says an improvement "which is made by the lessor of leased property for the lessee of such property" and which is abandoned at the termination of the lease "shall be treated for purposes of determining gain or loss under this title as disposed of by the lessor." The landlord built it for the tenant, the tenant left, the landlord accounts for what is left of it.

The tenant's side of a walkaway is the one to put in front of your CPA while the exit is still being negotiated rather than after. A tenant that spent $400,000 on a fit-out and recovered $140,000 of it over a six-year tenancy is leaving with $260,000 of basis in walls it no longer occupies. How that is handled depends on the facts of the disposition, and it is worth real money, which makes it worth asking about early.

The related trap is on the landlord's side at sale rather than lease end. Accelerated depreciation comes back on disposition, and the rate depends on what was accelerated. I laid out how that works in the post on selling a property after a cost segregation study.

Why one buildout is never one asset

Here is where the 15-versus-39 framing actually undersells what is available, because treating a buildout as a single bucket of qualified improvement property is itself a simplification.

Take a $400,000 restaurant fit-out. Inside that number there is decorative lighting and millwork and the specialty electrical feeding the kitchen line, much of which is personal property on a five-year or seven-year life. There is the interior framing and the general electrical and the HVAC distribution, which is where qualified improvement property lives at 15 years. If the work touched the site at all, there are land improvements, also 15-year. And there is structural work that stays at 39 no matter how the invoice was written. One check from the tenant, four different recovery periods.

A contractor's invoice will not tell you where those lines fall. It is organized by trade and by draw schedule, not by asset class. Pulling the components apart takes an engineering-based cost segregation study, which means an engineer costing out the actual installed components against the actual construction documents. Not a percentage applied to the total. Not a desktop estimate from photographs. A rule of thumb is a guess wearing a number's clothing, and it does not survive the first information document request.

It also means someone walking the space. A site visit is done in person by a trained professional, and on a buildout that matters more than it does on an acquisition, because the thing being valued is the work itself rather than a share of a purchase price. Somebody has to see what went in.

If the buildout happened in an earlier year and nobody ever separated it, that is recoverable. The catch-up runs through an accounting method change rather than an amended return, and I walked through the mechanics in the post on using Form 3115 to claim missed depreciation. If the buildout replaced something that was torn out, there is a second deduction sitting in the demolition, which is the subject of the step-by-step guide to partial asset disposition and qualified improvement property.

Frequently Asked Questions

Who depreciates tenant improvements, the landlord or the tenant? Generally the party that bears the cost of the improvement. If the landlord funds and capitalizes the work, the landlord depreciates it. If the tenant pays for its own fit-out, the tenant depreciates it, even though the landlord owns the building. The determination turns on who holds the benefits and burdens of the finished work, which a lease can place with either party, so the lease terms need to be read before either side claims the deduction.

Can a tenant depreciate improvements over the length of the lease? Not for tax purposes. Section 168(i)(8)(A) directs that improvements made on leased property are depreciated under the regular depreciation rules, which assign a recovery period based on what the asset is rather than how long the lease runs. Amortizing over the shorter of the lease term or useful life is a book convention for financial statements, not the tax treatment.

How long do you depreciate leasehold improvements? It depends on classification, not on the lease. Interior improvements to a commercial building that meet the definition of qualified improvement property have a 15-year recovery period under section 168(e)(3)(E)(vii). Work that is structural, or that enlarges the building, or that is an elevator or escalator, stays with the building at 39 years. A single buildout often contains components in several classes at once.

Does qualified improvement property require a lease? No. The definition in section 168(e)(6)(A) turns on the improvement being interior, being made to a nonresidential building, and being placed in service after the building was first placed in service. An owner-occupant renovating its own space qualifies on the same terms as a tenant.

Can you take 100 percent bonus depreciation on a tenant buildout? Usually, if the timing works. Qualified improvement property is 15-year property, which is within the 20-year ceiling for bonus depreciation. IRS Publication 946 (2025) states that Public Law 119-21 reinstated the 100 percent allowance for certain qualified property acquired and placed in service after January 19, 2025. For self-constructed work, IRS Notice 2026-11 treats construction as beginning when physical work of a significant nature starts, with a safe harbor at the point more than 10 percent of total cost has been paid or incurred.

Do tenant improvements in an apartment building qualify for the 15-year treatment? No. Qualified improvement property applies to nonresidential real property. Residential rental buildouts fall outside it and remain part of the building, though a cost segregation study can still separate out personal property and land improvements on a residential property.

What happens if the landlord pays the tenant a construction allowance? Section 110 may apply, and it moves the deduction. Where the lease is a short-term lease of retail space, 15 years or less, and the tenant spends the money on property that reverts to the landlord at lease end, the tenant excludes the allowance from income up to the amount actually spent, and section 110(b) treats the finished work as nonresidential real property of the landlord. The landlord gets the depreciation and the tenant gets tax-free cash.

The lease says who pays. The code says how fast.

Most buildout conversations end at the dollar amount: who is covering what, and how it shows up in the rent. The tax treatment gets decided by default weeks later, by whoever is entering fixed assets, and the default is almost always the slowest answer available.

That is the whole opportunity here. Nothing in this is aggressive and nothing in it is a loophole. Congress wrote a 15-year class for interior commercial improvements and wrote bonus depreciation on top of it, and the only reason money gets left on the table is that nobody classified the work when it was fresh and the construction documents were still on somebody's desk. Evading tax is a crime. Declining to volunteer money the law never asked you for is just doing the job.

If you have put money into a space, as the landlord or as the tenant, the no-cost analysis will tell you what a study would find and what it would be worth before you commit to anything. No obligation, no pitch, and nothing for you to pull together first. If the numbers say a study will not pay for itself on your property, I will tell you that and save you the fee.

Grab a time on Calendly at calendly.com/david-wiener/cs or call 770-224-8504, option two. The service details are at davidhwiener.com. Cost segregation, 179D and R&D credit studies are delivered through my relationship with CSSI (Cost Segregation Services, Inc.). We also talked through the landlord side of these decisions on the podcast, in the episode on the mistakes quietly killing landlord cash flow.

This article is educational and is not tax, legal, or accounting advice. Every situation is different; work with a qualified tax professional before acting on any strategy described here.