How do I account for leasehold improvements?
Monday, November 8, 2010 at 3:44PM Leasehold improvements are enhancements paid for by a tenant to leased space. Leasehold improvements generally revert to the ownership of the landlord upon termination of the lease, unless the tenant can remove them without damaging the leased property.
An example of leasehold improvements is offices constructed in unfinished office space.
When you pay for leasehold improvements, you should capitalize them if they exceed the corporate capitalization limit. If not, then charge them to expense in the period incurred. If you capitalize these expenditures, then amortize them over the shorter of their useful life or the remaining term of the lease. The remaining term of the lease for amortization purposes can be extended into additional lease renewal periods if the renewal is reasonably assured (such as when there is a bargain renewal option).
Technically, you are amortizing leasehold improvements rather than depreciating them. The reason is that the landlord owns the improvements, so you are only exercising an intangible right to use the improvements during the term of the lease - and intangible assets are amortized, not depreciated.
For example, ABC Company has a five-year lease on an office building, as well as an option to renew the lease for an additional five years at the then-prevailing market rate. ABC pays $150,000 to build offices in the building immediately after it leases the space. The useful life of these offices is 20 years. Since there is no bargain purchase option to renew the lease, it is not reasonably assured that ABC will renew the lease. Consequently, it should amortize the $150,000 over the five years of the existing lease, which is the shorter of the useful life of the improvements or the lease term. ABC will recognize $30,000 of amortization in each of the five years of the lease with the following entry:
| Debit | Credit | |
| Amortization expense | 30,000 |
|
| Accumulated amortization | 30,000 |
Related Topics
How do I account for land improvements?
How do I write off a fixed asset?
What is the accounting entry for depreciation?
What is the correct capitalization limit?
Reader Comments (11)
I agree that Leasehold improvements are intangible assets. In my company, we recently amortized them over the remaining term of the lease (ends March of next year) which was the shorter compared to the 5 years useful life of the assets.
This article is great as it clearly presents the subject follows by a good example. It helps me understand this process to better deal with future similar cases.
Thanks!
What happens to the Leasehold improvements if you buy the building? Is it now possible to extend the life?
If you buy the building, the term of the lease no longer limits the useful life of the leasehold improvements. You could then extend the useful life to the lesser of the life of the building or the life of the improvements.
This makes sense to me, as I have extended lives on leaseholds where the lease is extended. However, I'm having trouble finding guidance that supports this extension. Thank you for the reply.
That seems incorrect to simply extend the life of LHI when buying the building that was previously leased, as the building would have been appraised and purchased with the LHI included in the transaction.
That seems to absolutely perfect and this helped me a lot on the issue I had with LHI. One of the question is still unclear to me when we should start amortising Leasehold Improvements? When it should be accounted is it invoice date or after the works are finished? Please give references to Standards as well if possible.
Appreciate your help! Thanks
How is a tenant leasehold improvement depreciated on for taxes? I do not want to Section 179 this.
I own a retail chain of stores and have the option in my lease to close one location after the 5th year of a 10 year lease. The decision to close was made in December 2011 and the landlord was notified. The store will continue to operate until 6/30/12 due to a 6 month notice requirement.
There remains a significant amount of un-depreciated leasehold dollars on the books. It would be very beneficial to take the write-offs for the 2011 tax year rather than the 2012 tax year.
My question is: Since the deceision to close was made in 2001 can I take advantage of this stores closing in the 2011 tax year even though it will continue to operate for a 6 months in 2012?
I would guess that you simply adjust the useful life in the depreciation calculation for the remaining months before the lease is terminated, which means that most of the write off would occur in 2012. However, this is a question for your tax accountant to answer.
Who is responsible for the property taxes on the improvement during the leasehold period if the improvement was capitalized - lessor or tenant?
Responsibility for property taxes is not an accounting issue; instead, it should be identified in the lease agreement.