Leasehold improvements are capitalized as a fixed asset and amortized over the shorter of their useful life or the remaining lease term, per ASC 842-20-35-12. They are not part of the right-of-use asset and they are never netted against a tenant improvement allowance. Two exceptions extend the period to full useful life: the lease transfers ownership or the lessee is reasonably certain to exercise a purchase option, and, since ASU 2023-01, leases between entities under common control. For tax, the same buildout is usually qualified improvement property depreciated over 15 years, and it has been eligible for 100% bonus depreciation since the One Big Beautiful Bill Act.
The rule is one sentence. Applying it goes wrong in three predictable places: teams use the original lease term instead of the remaining term, they let a renewal option they never formally assessed decide the amortization period by accident, and they net the landlord's allowance against the asset. Each one lands in the same place, which is an amortization expense that is wrong every period until somebody restates it. This guide walks the rule, works the dollars, and shows where in the lease document each input actually comes from.
What are leasehold improvements?
Leasehold improvements are permanent alterations a tenant makes to a leased space that cannot practically be removed at the end of the term. Think of the difference this way: if the item stays with the building when you hand back the keys, it is a leasehold improvement. If you load it onto a truck, it is furniture, fixtures, or equipment, and it depreciates on its own schedule regardless of the lease.
| Usually a leasehold improvement | Usually not |
|---|---|
| Interior demising walls and partitions | Desks, chairs, and modular workstations |
| Built-in cabinetry, millwork, reception desks | Servers, monitors, and network gear |
| Flooring, ceilings, and permanent lighting | Signage you unbolt and take with you |
| Plumbing and electrical distribution within the suite | Building shell, roof, and structural framing |
| Specialty build-out such as lab benches or a clean room | Routine repairs and repainting between tenants |
Two items sit on the line often enough to be worth naming. Removable trade fixtures follow the removal test, not the invoice: if the lease requires you to take them out at surrender, they are not leasehold improvements. And landlord work delivered as part of the base building is the landlord's asset, not yours, even when your build-out drawings specified it.
Are leasehold improvements capitalized or expensed?
Capitalized, provided the cost exceeds your capitalization threshold and the work extends the life or utility of the space rather than simply maintaining it. Repainting a suite between tenants is maintenance expense. Reconfiguring that suite into twelve offices and a conference room is a capital improvement. Costs to capitalize include the construction contract, architecture and engineering fees, permits, and directly attributable project management. Costs to expense include moving, most furniture, and general administrative overhead you would have incurred anyway.
The capitalized figure has to tie back to the general contractor's pay applications and the vendor invoices behind them, which is the audit sample nobody enjoys reconstructing eighteen months later. Teams running several build-outs at once usually extract the line items off those invoices automatically and code them at intake, rather than rebuilding the schedule from a folder of PDFs at year end.
How long do you depreciate leasehold improvements?
Over the shorter of the useful life of the improvements or the remaining lease term. That word does most of the damage in practice. The period runs from the date the improvements are placed in service to the end of the lease term, not from the lease commencement date. Improvements built in year three of a seven-year lease amortize over four years, not seven.
ASC 842-20-35-12 sets out the two exceptions that push the period out to full useful life: the lease transfers ownership of the underlying asset to the lessee, or the lessee is reasonably certain to exercise a purchase option. In either case you will end up owning the asset, so limiting amortization to the lease term would understate its life. A third exception, common control, is covered further down.
A worked example, and the judgment that moves it
A tenant signs a seven-year office lease with one five-year renewal option and spends $1,400,000 on a build-out with a 15-year useful life. Because 15 years exceeds any version of the lease term here, the lease term controls the answer in every scenario.
| Scenario | Amortization period | Annual expense |
|---|---|---|
| Placed in service at commencement, renewal not reasonably certain | 7 years | $200,000 |
| Placed in service at commencement, renewal reasonably certain | 12 years | $116,667 |
| Placed in service in year 3, renewal not reasonably certain | 4 years remaining | $350,000 |
The spread between the first and third rows is $150,000 a year on identical construction. The spread between the first and second is $83,333 a year, and it turns entirely on whether one renewal option is reasonably certain of exercise. Nothing about the concrete changed.
That second judgment is the one worth sitting with, because it is not a fixed asset decision at all. It is a lease term conclusion, and it has to match the conclusion you reached when you measured the right-of-use asset and lease liability for the same lease. Deciding the renewal is reasonably certain for the lease liability and then amortizing the improvements over seven years is internally inconsistent, and it is the kind of inconsistency an auditor finds by comparing two schedules that were prepared by two different people. A large, purpose-built improvement with no alternative use is itself evidence that renewal is economically compelled, which is exactly the reasoning ASC 842 asks for. Our guide to operating lease vs finance lease classification works through how the same reasonably-certain test flips a classification, and the renewal option extraction page covers pulling the windows and rent basis out of the document.
Are leasehold improvements part of the right-of-use asset?
No. They are a separate fixed asset on your balance sheet, recorded and amortized independently of the ROU asset. This trips people up because both arise from the same lease and both amortize over periods derived from the lease term, so they look related. They are not. The ROU asset represents your right to use the landlord's space. The leasehold improvements are property you built and control.
Three balances that get confused, kept straight:
| Item | What it is | Where it goes |
|---|---|---|
| Leasehold improvements | Construction you paid for and control | Property and equipment; amortized to operating expense |
| Right-of-use asset | Your right to use the leased space | Separate ROU line; drives straight-line lease cost |
| Tenant improvement allowance | A lease incentive from the landlord | Reduces the ROU asset, not the improvement asset |
That third row is the most expensive error in this entire topic. A $500,000 allowance against a $1,400,000 build-out does not leave you with a $900,000 leasehold improvement asset. You capitalize the gross $1,400,000 and amortize it, and the $500,000 incentive reduces the ROU asset, which lowers straight-line lease cost over the term. Netting it collapses two separate expense streams into one and understates both your fixed assets and your lease cost. The allowance is also not revenue. Our tenant improvement allowance accounting guide walks the journal entries under both ASC 840 and ASC 842, and the allowance sits inside the broader family of lease incentives under ASC 842, where the timing of the money changes the opening balance sheet. If you are still standing the whole thing up, the ASC 842 implementation guide covers the lease population and the expedient elections that come first.
Who pays matters: tenant-funded versus landlord-funded improvements
The party that bears the economic cost and controls the asset capitalizes it. Work the tenant contracts for and pays for is a tenant leasehold improvement, even when a landlord allowance reimburses part of it. Work the landlord contracts for, pays for, and owns is the landlord's building improvement, depreciated on the landlord's books over the building's life, and the tenant records nothing.
The determination is made from the lease and the work letter, not from whose name is on the check. Read for who holds the construction contract, who bears cost overruns, who owns the improvements during the term, and what happens at surrender. A work letter where the landlord builds to your specification but you fund every dollar over an allowance is a tenant improvement for the amounts you fund. A restoration obligation requiring you to demolish the build-out at expiration is a separate asset retirement consideration and does not change the capitalization.
Did ASC 842 change leasehold improvement accounting?
Barely, and that surprises people who expected the new standard to touch everything. The shorter-of-useful-life-or-lease-term rule carried over from ASC 840 essentially unchanged, and it applies the same way whether the lease is classified as operating or finance. What ASC 842 changed is the surrounding structure: the ROU asset and lease liability now sit on the balance sheet, and the lease term determination that drives your amortization period is now the same determination that drives the liability measurement, so an inconsistency between the two is visible in a way it never used to be.
The one substantive change since is ASU 2023-01, Leases (Topic 842): Common Control Arrangements, issued March 2023 and effective for fiscal years beginning after December 15, 2023. Under it, leasehold improvements associated with a lease between entities under common control are amortized over the useful life of the improvements to the common control group, regardless of the lease term, as long as the lessee controls the use of the underlying asset. FASB made the change because related-party leases are frequently short or informal while the improvements last decades, and forcing amortization over a one-year intercompany term did not reflect the economics. If your operating company leases from an entity the same owners control, this applies to you.
Book versus tax: qualified improvement property in 2026
The GAAP answer above governs your financial statements. Your tax depreciation is a different calculation with a different life, and treating them as the same number is a common small-company mistake.
Most interior build-outs qualify as qualified improvement property, which the IRS assigns a 15-year recovery period rather than the 39 years that applies to nonresidential real property. QIP means an improvement to an interior portion of an existing nonresidential building, placed in service after the building was first placed in service. It specifically excludes enlargement of the building, elevators and escalators, and anything touching the internal structural framework.
Two provisions make the timing far more favorable than 15 years suggests. QIP is eligible for bonus depreciation, and the One Big Beautiful Bill Act, signed July 4, 2025, made 100% bonus depreciation permanent for qualified property acquired and placed in service after January 19, 2025, removing the phase-down that would have cut the rate to 20% in 2026. QIP is also eligible for Section 179 expensing, where the same law raised the annual limit to $2.5 million with a $4 million phaseout threshold for property placed in service after December 31, 2024. Both are federal; state conformity varies, and several states decouple from bonus depreciation entirely, so confirm your state before you model the cash benefit. This is general information rather than tax advice, and the eligibility tests reward a conversation with your tax preparer.
Journal entries and balance sheet presentation
Capitalization is straightforward. Using the $1,400,000 build-out amortized over a seven-year remaining term:
| Event | Debit | Credit |
|---|---|---|
| Costs incurred during construction | Construction in progress $1,400,000 | Cash or accounts payable $1,400,000 |
| Placed in service | Leasehold improvements $1,400,000 | Construction in progress $1,400,000 |
| Each year of the term | Amortization expense $200,000 | Accumulated amortization $200,000 |
On the balance sheet, leasehold improvements sit within property and equipment, net of accumulated amortization, separate from the ROU asset line. Whether you label the expense amortization or depreciation is presentation preference and both appear in practice, since the asset is tangible but its life is limited by a contract. Pick one and apply it consistently. If you abandon the space before the end of the term, write off the remaining net book value in the period the decision is made rather than continuing to amortize a space you have left.
Where the inputs actually come from
Every number in this guide except the construction cost comes out of the lease document set. The remaining lease term depends on the commencement date, the stated expiration, and every amendment that has moved either one. The reasonably-certain judgment depends on the renewal option clause, its notice window, and the rent basis on renewal. The allowance treatment depends on the work letter. The restoration question depends on the surrender clause.
For a single lease that is an afternoon with a highlighter. Across a portfolio of 200 leases with amendment chains, it is the reason fixed asset schedules and lease schedules disagree. A structured abstract that pulls the date set, the option windows as calculated dates, the allowance, and the surrender obligations into fields, each one linked back to the page and clause it came from, means your amortization period can be traced to a document instead of to whoever set it up. Leaseabstracts does that in minutes per lease. See the ASC 842 lease data extraction page for the full input list, or the lease commencement date guide for the date that starts every one of these clocks.
Frequently asked questions
Are leasehold improvements amortized or depreciated?
Both terms appear in practice and neither is wrong. US GAAP language in ASC 842-20-35-12 uses amortized, because the asset's life is limited by the lease contract rather than by physical wear. Many companies label it depreciation because the asset is tangible and sits in property and equipment. The accounting is identical either way: straight-line over the shorter of useful life or remaining lease term. Choose one label and use it consistently.
What is the useful life of leasehold improvements?
The useful life is your own estimate of how long the improvements will remain economically useful, typically 10 to 20 years for standard office and retail build-outs. It is only half the answer, though, because you amortize over the shorter of that life and the remaining lease term, and the lease term is shorter than the useful life in almost every commercial lease. For tax, qualified improvement property has a fixed 15-year recovery period.
Do leasehold improvements go on the balance sheet?
Yes. Leasehold improvements are capitalized within property and equipment and carried net of accumulated amortization, on a line separate from the right-of-use asset. They are your asset even though you do not own the building, because you paid for the work and control its use during the lease term. Only costs below your capitalization threshold or classified as maintenance are expensed as incurred.
Who owns leasehold improvements at the end of the lease?
Almost always the landlord, because the improvements are permanently affixed to the building. The tenant capitalizes and amortizes them during the term because it controls their use, then they revert with the premises at expiration. Check the surrender clause, though: some leases require the tenant to remove specified improvements and restore the space, which creates a separate obligation to account for.
Can leasehold improvements be amortized over a period longer than the lease term?
Only in three situations. The lease transfers ownership of the underlying asset to the lessee, the lessee is reasonably certain to exercise a purchase option, or the lease is between entities under common control and the lessee controls the use of the asset, per ASU 2023-01. Renewal options do not create an exception, but options judged reasonably certain of exercise lengthen the lease term itself, which lengthens the period.
How do I account for leasehold improvements paid for by the landlord?
If the landlord contracts for, funds, and owns the work, it is the landlord's building improvement and the tenant records nothing. If the landlord reimburses tenant-funded work through a tenant improvement allowance, the tenant capitalizes the gross construction cost and treats the allowance as a lease incentive that reduces the right-of-use asset. Never net the allowance against the leasehold improvement asset.