A leasehold (or tenant) improvement is a tangible build-out or structural change to the interior of leased non-residential real estate made by a lessee to suit his needs. These improvements can be capitalised and depreciated by the lessee if the improvements meet certain guidelines.
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What May Be Capitalized
A leasehold improvement can be nearly any tangible build-out made in leased space. Items such as interior partitions, room build-outs, floor finishes, carpeting and lighting fixtures may be capitalised. These capitalised improvements must be made in a part of the building that is used exclusively by the lessee and placed into service at least three years after the building's construction.
What May Not Be Capitalized
Certain types of build-outs are not allowed to be capitalised as leasehold improvements. The lessee may not capitalise an enlargement of the building, improvements to elevators and escalators, and changes to a building's internal structure or common areas. Additionally, routine maintenance and repairs and movable partitions and office furniture may not be classified as leasehold improvements.
The lessee may depreciate the cost of properly capitalised leasehold improvements over the shorter of the usable life of the improvement or the remaining life of the lease.
A lessor may offer a lessee a monetary incentive if she finds a leasehold improvement to be beneficial to the leased space. According to the Securities and Exchange Commission, the lessee should treat this payment as deferred rent and amortise it over the shorter of the usable life of the associated improvement or the remaining life of the lease.
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