Tenant Improvement Allowance Accounting: Capitalize, Amortize or Expense?

How you account for a tenant improvement (TI) allowance depends on one question: who owns the improvements? If the landlord owns them, the landlord capitalizes the cost as a building improvement and depreciates it. If the tenant owns them, the allowance is a lease incentive, and the landlord spreads it as a reduction of rental income over the lease term. The same $300,000 check can be a fixed asset in one lease and a reduction of rent in another.

Tax treatment follows its own rules and often differs from GAAP. Here is how each side should book it.

What Is a Tenant Improvement Allowance?

A TI allowance is money a landlord provides to build out or improve a tenant's space, such as new walls, flooring, lighting, HVAC distribution or finishes. It is usually negotiated as a dollar amount per square foot and paid either directly to contractors or reimbursed to the tenant against invoices.

TI allowances are common in office, retail and medical leases, and they are a significant part of the economics of a commercial lease alongside rent, free rent and term.

How Do You Decide Who Owns the Improvements?

Ownership is a judgment based on the lease and the facts, not just who paid. Factors that point toward landlord ownership:

• The improvements are general-purpose and useful to future tenants, such as standard HVAC, restrooms or base building upgrades.
• The landlord controls the design and construction.
• The lease says improvements become landlord property and stay at lease end.
• The landlord pays contractors directly.

Factors that point toward tenant ownership:

• The improvements are specific to the tenant's business, such as a branded store fit-out or specialized equipment.
• The tenant controls design and construction.
• The tenant can remove the improvements at lease end.
• The landlord simply reimburses the tenant for its own build-out.

Document the conclusion for each lease. Your auditor will ask.

How Does the Landlord Account for a TI Allowance?

If the landlord owns the improvements

• Capitalize the cost as building or tenant improvements.
• Depreciate over the shorter of the improvement's useful life and the lease term for GAAP.
• If the lease ends early, write off the remaining net book value.

If the tenant owns the improvements

• Record the allowance paid as a lease incentive, typically a deferred asset.
• Amortize it as a reduction of rental income on a straight-line basis over the lease term, together with the rest of the lease's straight-line rent.
• If the lease ends early, write off the unamortized balance.

A worked example

A landlord gives a $300,000 TI allowance on a 10-year office lease (120 months).

Both spread the cost over the lease, but one appears as depreciation below net operating income and the other reduces rental revenue. That difference changes NOI, which in turn affects valuation and some loan covenants, so the classification matters.

How Does the Tenant Account for a TI Allowance?

Under ASC 842, a lease incentive received from the landlord reduces the tenant's right-of-use asset. If the tenant owns the improvements, the tenant capitalizes the construction cost as leasehold improvements and amortizes them over the shorter of their useful life and the lease term.

If the landlord owns the improvements and pays for them directly, the tenant generally does not record the improvements at all.

How Do TI Allowances Interact With Straight-Line Rent?

For the landlord, a lease incentive paid to a tenant is treated as a reduction of the total lease payments. That means it becomes part of the straight-line rent calculation: total fixed rent minus incentives, spread evenly over the term. Make sure the lease setup in your software includes the incentive, not just the rent schedule.

How Are TI Allowances Treated for Tax?

Tax treatment often differs from GAAP, so confirm each situation with your tax adviser. A few common points:

• Landlord-owned improvements are depreciated by the landlord for tax. Qualifying interior improvements to nonresidential buildings may be eligible for a shorter recovery period and bonus depreciation, depending on current law. Bonus depreciation rules changed again in 2025.
• Tenant-owned improvements funded by an allowance can create taxable income for the tenant, unless an exception applies.
• Section 110 provides a safe harbor for certain short-term leases of retail space, allowing a tenant to exclude a construction allowance from income if it is used for qualified improvements, with matching treatment for the landlord.
• When a lease ends early, the landlord can generally deduct the remaining undepreciated basis of improvements that are abandoned or disposed of.

What Should the Lease Abstract Capture?

To book TI correctly, the abstract should record:

• Total allowance amount and per-square-foot rate
• Who controls construction and who owns improvements
• Payment method (direct to contractors or reimbursement)
• Deadlines for the tenant to use the allowance
• Whether unused allowance can be applied to rent
• Restoration or removal obligations at lease end

Our guide to critical date tracking from lease abstraction covers how to track TI usage deadlines.

Common TI Accounting Mistakes

• Expensing the whole allowance when it is paid
• Recording tenant-owned improvements as landlord fixed assets
• Depreciating improvements over the building life instead of the lease term
• Leaving the incentive out of straight-line rent
• Forgetting to write off remaining balances when a tenant leaves early
• Treating unused allowance applied to rent as free rent without updating the schedule

Getting TI Right

TI allowances are one of the largest numbers in a commercial lease, and the classification flows through NOI, valuation and taxes. Vertex Accounting reviews lease terms, records TI correctly and keeps straight-line schedules current for commercial real estate owners as part of monthly real estate accounting.