Tenant improvement allowance accounting can be done a variety of ways, depending on who pays for the improvements and who oversees the improvements. The structuring of the transactions between the landlord and the tenant determines the accounting entries that will be made. The landlord could pay the tenant so that they can make the improvements themselves or they could pay for the improvements and let the tenant oversee the work. The tenant may also decide to pay for and supervise the improvements themselves, and then depreciate them (i.e. deduct from rental payments) over the course of their stay. Depending on which of these scenarios occurs, the accounting entries will differ slightly.
Tenant Improvement Allowance Accounting
A tenant incentive is a way for landlords to keep tenants satisfied and happy. Accounting for tenant improvements paid by the landlord is a great way to show this. The landlord could pay the tenant so they can make the improvements themselves or they could pay for the improvements and let the tenant oversee the work. The tenant may also decide to pay for and supervise the improvements themselves, and then the landlord will depreciate them over the course of their stay. There are different tenant improvement allowance journal entries depending on which of these scenarios we consider.
A Look at Depreciation
Generally speaking, the landlord will be in charge of depreciating the value of the improvements that have been made to the property. Say, for example, that the improvements had a total cost of $1,500. The landlord would take that figure and divide it over several years. The figure obtained would be deducted from the rental income every year. The number of years varies depending on whether the property is residential or non-residential. Generally, residential properties will be depreciated over a period of 27.5 years while non-residential properties will be depreciated over a period of 39 years. If the cost of the improvement was incurred on equipment, fixtures and furniture, which aren’t considered permanent improvements, then the depreciation period will be seven years.
Cash in Exchange for Work
In the scenario where the landlord gives the tenant cash for improvement work, the tenant is required to record that allowance as income, and then depreciate it over a given period. If the time happens to be longer than the period of the lease on the property, then the tenant will have to write the remaining amount off.
The landlord, on their part, will be required to amortize the amount over the term of the lease. Amortization is pretty much similar to depreciation in that it marks how much of an asset has been used up. The major difference, however, is that with amortization the asset is intangible while with depreciation it is tangible. In this case, the asset is the amount the landlord has spent on the rental property.
When the Landlord Makes the Improvements
If the landlord has made the allowance and still makes the improvements themselves, then they own those improvements. In this case, they will depreciate the cost of those improvements over the period of the lease. If another tenant moves into the property and doesn’t require further improvements, then the landlord can continue their depreciation schedule until they have exhausted the value of the improvements. Should the property be demolished before the value is used up, then the landlord is required to write off the remaining amount of the value. The tenant doesn’t make any entries in this scenario.
When Work Substitutes Rent
There is the scenario where the tenant makes the improvements themselves and deducts the cost of the improvements from their rent. In this case, they will enter the deductions as income in their accounts. The landlord will treat the rent as a cash payment but will still depreciate the amount associated with the improvements.
- Internal Revenue Service: Residential Rental Property
- Lease Ref: Tenant Improvement Allowance: A Complete Guide
- HHCPA: Accounting for Lease Incentives and Tenant Allowances
- Accounting Tools: Accounting for a tenant improvement allowance
- Internal Revenue Service. "New Rules and Limitations For Depreciation and Expensing Under the Tax Cuts and Jobs Act." Accessed April 30, 2020.
Nicky is a business writer with nearly two decades of hands-on and publishing experience. She's been published in several business publications, including The Employment Times and Business Idea Factory. She also studied business in college.