Real Estate Tax Calc
What are tenant improvements?
Tenant improvements (TIs) are alterations made to leased commercial space — new walls, flooring, lighting, HVAC modifications, or buildout for a specific tenant's use. When the landlord pays for these improvements (sometimes called a tenant improvement allowance paid to the tenant, or direct landlord construction), they become the landlord's depreciable asset.
The amount a landlord spends on TIs is capitalized into the landlord's basis in the property. The depreciation schedule depends on what type of property the improvements are classified as.
Qualified Improvement Property: the 15-year shortcut
The CARES Act (2020) permanently fixed a prior drafting error in the Tax Cuts and Jobs Act, establishing that Qualified Improvement Property (QIP) — interior improvements to commercial buildings already placed in service — is a 15-year asset eligible for 100% bonus depreciation (at current rates). This is a significant benefit: instead of depreciating tenant improvements over 39 years, a landlord can potentially deduct the full cost in year one.
To qualify as QIP, the improvement must be: (1) to the interior of a nonresidential (commercial) building, (2) to a building already placed in service, (3) not attributable to enlarging the building, installing an elevator or escalator, or making structural changes to the internal framework. Leasehold improvements in a residential rental don't qualify as QIP — they follow the standard 27.5-year residential depreciation schedule.
What doesn't qualify and how to handle it
Structural improvements that enlarge a commercial building, new construction, or improvements to residential buildings do not qualify as QIP. These generally follow 39-year (commercial) or 27.5-year (residential) straight-line depreciation.
A cost segregation study on tenant improvements can reclassify components into personal property (5- or 7-year) if they are not structural — lighting, plumbing fixtures, specialty flooring — which can qualify for bonus depreciation separately. For large TI buildouts, a cost segregation study may identify components that get even faster depreciation than the 15-year QIP category. Track tenant improvements separately in your depreciation schedule, with placed-in-service dates and amounts, so they can be properly depreciated or disposed of at lease end.
The bonus depreciation rate on QIP today
The bonus depreciation percentage on Qualified Improvement Property has changed repeatedly, so pin down the rate for the year the improvement was placed in service. Under the Tax Cuts and Jobs Act phase-down, the rate was 80% in 2023, 60% in 2024, and scheduled to fall to 40% in 2025 before expiring. The One Big Beautiful Bill Act (OBBBA) then permanently restored 100% bonus depreciation for qualifying property acquired and placed in service after January 19, 2025. QIP with a 15-year GDS recovery period qualifies, so a landlord who completes a commercial buildout that meets the QIP definition after that date can generally expense the entire cost in year one.
Bonus depreciation is automatic unless you elect out, and the election out is made on a class-by-class basis (for QIP, the 15-year class). Electing out can make sense if you cannot use a large first-year deduction — for a passive investor whose losses would simply suspend, spreading the deduction over 15 years may match income better. Always confirm the placed-in-service-year rate against current IRS guidance before you file, because this figure is exactly the kind of number that shifts with each tax bill.
A worked example: expensing a $150,000 buildout
Suppose you own a strip-center suite and spend $150,000 in 2025 building out interior space for a new tenant — demising walls, drop ceilings, interior lighting, flooring, and finishes — none of it enlarging the building or altering the structural framework. The work is completed and the space is placed in service on September 1, 2025.
The improvements meet the QIP definition, so they are 15-year property eligible for 100% bonus depreciation. Rather than deducting roughly $10,000 a year for 15 years, you deduct the full $150,000 in 2025. If the buildout instead included moving a load-bearing wall or adding square footage, that portion would be excluded from QIP and depreciated over 39 years. This is why keeping the contractor's cost breakdown matters: the structural and enlargement portions must be split out from the QIP-eligible interior work, and only the qualifying interior costs get the fast write-off.
Section 179 as an alternative to bonus depreciation
Bonus depreciation is not the only route to first-year expensing. Section 179 also lets a landlord immediately deduct QIP, and the TCJA expanded 179 to cover certain nonresidential building improvements — roofs, HVAC, fire protection and alarm systems, and security systems — that fall outside the QIP definition. For 2025 the Section 179 deduction limit is roughly $1.25 million (indexed annually), with a dollar-for-dollar phase-out once total qualifying purchases exceed about $3.13 million.
The key differences: Section 179 is limited to taxable business income (it cannot create or increase a loss), while bonus depreciation can create a loss. Section 179 is also elected item-by-item, giving you finer control, whereas bonus applies to a whole class unless you elect out. Many landlords use 179 for the components bonus cannot reach (an HVAC replacement on a commercial building) and rely on bonus depreciation for the QIP itself. Note that Section 179 is generally not available for property used in residential rental activity, so it is primarily a commercial-landlord tool.
Allowances vs. landlord-built improvements: who deducts what
The tax owner of the improvement — not whoever writes the check — determines who depreciates it. When a landlord builds out the space directly, or pays a tenant improvement allowance that funds improvements which revert to the landlord at lease end, the landlord capitalizes and depreciates the cost. If instead the tenant pays for and owns improvements it can remove, the tenant depreciates them over the applicable recovery period (generally 15-year QIP or 39-year, not the lease term).
A construction allowance can also qualify for a special safe harbor under IRC Section 110: for a short-term lease (15 years or less) of retail space, a qualified lessee construction allowance the tenant uses to build out the space is excluded from the tenant's income, and the landlord then owns and depreciates the resulting improvements. Getting the ownership and the Section 110 mechanics right in the lease avoids a mismatch where both parties — or neither — claim the depreciation.
Partial dispositions when a tenant leaves
When a tenant vacates and you demolish or replace their buildout for the next tenant, the remaining undepreciated basis of the old improvements does not have to sit on your books for years. Under the tangible property regulations (Treas. Reg. §1.168(i)-8), you can make a partial disposition election to write off the adjusted basis of the retired improvements as a loss in the year you remove them.
This does two useful things: it accelerates a deduction you would otherwise recover slowly, and it stops you from depreciating an asset that no longer exists while also depreciating its replacement (which would otherwise inflate future recapture). The demolition and removal costs of the old buildout are generally added to the basis of the new improvements rather than deducted immediately. Keep a clear asset ledger showing each buildout's cost and placed-in-service date so you can identify exactly what basis is being retired.
Recapture and state conformity at sale
Improvements you expensed with bonus depreciation or Section 179 are not free of tax forever — they lower your basis, so they increase the gain when you sell. QIP is Section 1250 real property, so the depreciation you claimed on it (including bonus depreciation) is generally recaptured as unrecaptured Section 1250 gain, taxed at a maximum of 25%, while any components a cost segregation study reclassified as Section 1245 personal property are recaptured as ordinary income. Model this before you sell, because a large first-year deduction converts into a recapture bill later.
State treatment is a second wrinkle. Many states have decoupled from federal bonus depreciation and some limit Section 179, so an improvement you fully expensed on your federal return may have to be depreciated over its normal life for state purposes. That means maintaining a separate state depreciation schedule and basis for the same asset until you dispose of it. Confirm your state's conformity before assuming the federal write-off carries through to your state return.
Frequently asked questions
Can I take bonus depreciation on tenant improvements I pay for?
Yes, if the improvements qualify as QIP (interior improvements to a commercial building already placed in service, not enlarging it or altering the structural framework). Under the One Big Beautiful Bill Act, bonus depreciation is 100% for qualifying property placed in service after January 19, 2025; earlier years used the phase-down rates (60% in 2024, 80% in 2023). Confirm the rate for your placed-in-service year.
What happens to unamortized tenant improvement costs when the tenant leaves?
If you can demonstrate that the improvements are abandoned or worthless, you may be able to take a partial disposition loss for the remaining basis under Treas. Reg. §1.168(i)-8. Demolition costs of the old buildout are generally capitalized into the new improvements rather than deducted immediately.
Do tenant improvement allowances paid to tenants get depreciated?
Yes. A TI allowance paid to the tenant, which the tenant uses to build out the space, is the landlord's depreciable asset — assuming the improvements revert to the landlord at lease end.
Can I use Section 179 instead of bonus depreciation on a commercial buildout?
Often, yes. Section 179 can expense QIP and also reaches roofs, HVAC, fire protection, and security systems on nonresidential buildings that fall outside the QIP definition. Unlike bonus depreciation, the 179 deduction cannot exceed your business taxable income (it cannot create a loss) and is subject to an annual dollar limit (about $1.25 million for 2025). It is generally not available for residential rental property.
Is bonus depreciation on QIP recaptured when I sell?
Yes. QIP is Section 1250 real property, so the depreciation you claimed — including bonus depreciation — generally comes back as unrecaptured Section 1250 gain taxed at up to 25%. Components reclassified as Section 1245 personal property in a cost segregation study are recaptured at ordinary rates. A large first-year deduction becomes a recapture item at sale.
Does my state allow the same first-year write-off?
Not always. Many states have decoupled from federal bonus depreciation and some limit Section 179, so you may have to depreciate the improvement over its normal recovery period for state purposes and keep a separate state basis. Check your state's conformity before assuming the federal deduction carries through.
Sources
- IRS Publication 946 — How to Depreciate Property
- IRS — Cost Segregation Audit Techniques Guide
- IRS Publication 527 — Residential Rental Property
Educational information and estimates only. Not tax advice. Tax rules change and vary by situation; consult a qualified tax professional before acting.