Cost Segregation · Brief · Working level
Tenant improvements: who depreciates what, and over how long
Ownership, not occupancy, decides who deducts a build-out. Landlord-owned improvements are the landlord's asset; tenant-owned improvements depreciate over MACRS lives regardless of lease term; Section 110 construction allowances shift ownership by contract. QIP status and the Section 168(i)(8) lease-termination write-off complete the map.
Who deducts a tenant build-out is a question of tax ownership, and tax ownership follows the lease economics — who pays, who keeps the improvements, who bears the risk — not who sits in the space. Get the ownership answer first; the depreciation answer follows mechanically. A tenant that owns its improvements depreciates them over regular MACRS recovery periods, and Section 168(i)(8)(A) expressly forbids depreciating over the (usually shorter) lease term. A landlord that owns them adds them to its building schedule, with qualified improvement property treatment doing most of the heavy lifting on timing.
The four regimes
Tenant-owned improvements. The tenant funds the work and the lease treats the improvements as the tenant's property during the term. The tenant capitalizes and depreciates under regular MACRS — and much of a modern interior build-out qualifies as QIP (interior improvements to nonresidential property placed in service after the building), meaning 15-year recovery and 100 percent bonus for property acquired after January 19, 2025. Components that are really Section 1245 personal property — trade fixtures, dedicated equipment connections, demountable partitions — do even better at 5 or 7 years; the classification discipline is the same as in a cost segregation study. When the lease ends and the tenant walks away from unrecovered basis, the tenant takes a disposition loss for the remaining basis of improvements it abandons.
Landlord-owned improvements. The landlord funds the build-out (directly or through a turnkey delivery) and owns it. The landlord depreciates — QIP where the work is interior nonresidential and non-structural; 39-year for structural elements, enlargements, elevators, and escalators, which Section 168(e)(6)(B) excludes from QIP. Cash the landlord pays the tenant without Section 110 protection, where the tenant owns the resulting improvements, is generally income to the tenant (a lease inducement) with offsetting basis — an ugly result the parties usually structure around.
Section 110 construction allowances. For retail tenants under leases of 15 years or less, Section 110 provides the structured middle path: the landlord pays an allowance, the tenant builds, the tenant excludes the allowance from income, and the improvements are treated as the landlord's nonresidential real property from day one. Treas. Reg. §1.110-1 requires the lease to state that the allowance is for constructing or improving qualified long-term real property, and both parties file consistent information statements. The tenant gets no basis; the landlord depreciates.
Lease termination — Section 168(i)(8)(B). When a tenant leaves and the landlord demolishes the old build-out for the next tenant, the landlord deducts the remaining adjusted basis of improvements it made for the departing tenant — an irrevocable disposition or abandonment is required. This is the lease-cycle cousin of the partial disposition election, and it only works if the landlord's fixed-asset records track each tenant's improvements as separate assets rather than one blended building number.
Depreciation at a glance
Recovery treatment by regime, nonresidential space (post-January 19, 2025 acquisitions; bonus at 100%).
| Regime | Who depreciates | Typical recovery |
|---|---|---|
| Tenant-owned build-out | Tenant | QIP 15-yr w/ bonus; §1245 items 5/7-yr w/ bonus; structural 39-yr |
| Landlord-owned build-out | Landlord | Same classification, landlord's schedule |
| §110 allowance (retail, ≤15-yr lease) | Landlord | Nonresidential real property in landlord's hands |
| Termination write-off, §168(i)(8)(B) | Landlord | Remaining basis deducted at disposition |
Where it goes wrong
Three recurring failures. First, leases that never say who owns the improvements — leaving both parties to claim (or neither to claim) the depreciation, an easy exam adjustment. Second, tenants amortizing build-outs over the lease term out of financial-statement habit; Section 168(i)(8)(A) says MACRS lives, full stop, and the fix is an accounting method change on Form 3115. Third, landlords carrying dead build-out basis for decades because no one recorded the demolition — the Section 168(i)(8)(B) loss is use-it-at-termination. Pub 946 covers the mechanics; the drafting happens long before the return does.
Frequently asked questions
- Who depreciates tenant improvements — the landlord or the tenant?
- Whoever owns them for tax purposes, which follows the lease and the economics, not who occupies the space. If the tenant pays for and owns the build-out, the tenant depreciates it over regular MACRS lives — not over the lease term, per Section 168(i)(8)(A). If the landlord funds and owns the improvements, the landlord depreciates them and the tenant has no deduction beyond rent.
- What is a Section 110 construction allowance?
- Section 110 lets a landlord give a retail tenant a construction allowance under a short-term lease (15 years or less) for improvements the tenant builds. The tenant excludes the allowance from income, but the improvements are treated as the landlord's nonresidential real property — the landlord depreciates them, and the tenant has no basis in them. The allowance must be used for qualified long-term real property in the retail space.
- Can a landlord write off tenant improvements when the tenant leaves?
- Yes. Under Section 168(i)(8)(B), a landlord who disposes of or abandons improvements it made for a tenant upon termination of that tenant's lease may take the remaining adjusted basis into account as a loss at termination — typically when the space is gutted for the next tenant. The improvements must actually be irrevocably disposed of or abandoned, and documentation of the demolition matters.