How long can a building owner or landlord depreciate a leasehold improvement?

Leasehold improvements have different depreciation rules depending on whether you are working with U.S. tax basis financial reporting or U.S. generally accepted accounting principles (GAAP) financial reporting. For tax purposes, leasehold improvements are eligible to be depreciated over 15 years.

The 15-year rule was enacted by the Internal Revenue Service (IRS) in 2004. Prior to that year, the depreciation term was 39 years. The 15-year rule is not permanent and must be reauthorized every year. The depreciation term is fixed regardless of the actual useful life of the leasehold improvement or the remaining term of the lease.

For GAAP financial reporting, improvements to leaseholds can be capitalized or expensed depending on the dollar amount of the improvement. Companies set a capitalization limit, an internal accounting standard determined by management that sets the threshold amount above which an item is capitalized instead of expensed. If the amount does not exceed the capitalization limit, the leasehold improvement is expensed in the period in which it is incurred. If, however, the cost exceeds the capitalization limit, the company capitalizes and amortizes it.

A capitalized leasehold improvement under GAAP is amortized over the lesser of the remaining useful life or the remaining term of the lease. Useful life is determined based on management estimates. Additionally, the remaining term of the lease can include extensions so long as they are foreseeable and reasonably assured of happening. If the building is subsequently purchased, the lease ceases to be in effect, and the leasehold improvement would be amortized over the remaining useful life of the building.