Tax Treatment of Leasehold Improvements: Depreciation Rules for Tenants and Landlords

Leasehold improvements are one of the most tax-advantaged business expenditures under current law. Under IRC 168(k), qualified improvement property (QIP), which includes most interior improvements to nonresidential real property, qualifies for 100% bonus depreciation, allowing tenants to deduct the entire cost of a build-out in the first year. QIP is defined as any improvement to an interior portion of a nonresidential building placed in service after the building was first placed in service, excluding enlargements, elevators/escalators, and changes to the building’s internal structural framework. The 15-year MACRS recovery period for QIP was established by the CARES Act’s technical correction (fixing the original TCJA drafting error that assigned QIP a 39-year life), and bonus depreciation has been restored at 100% by the OBBBA, with no scheduled end date, for property acquired after January 19, 2025. For tenants who invest significantly in build-outs (restaurants, medical offices, retail spaces, professional offices), this creates a substantial first-year tax deduction that can offset other income.

How are leasehold improvements handled for tax?

Should a tenant expense a build-out with 179 or bonus?

A tenant’s interior build-out in a nonresidential building can be qualified improvement property, which is 15-year property eligible for 100% bonus if acquired after January 19, 2025. It can also take Section 179, but only if you elect to treat it as qualified real property. Either one can write off the full cost in year one, so the choice comes down to control and income.

• Section 179 lets you pick the amount, down to part of a single improvement, but it can’t exceed your taxable income from active trades or businesses. The rest carries forward.
• Bonus applies automatically to all 15-year property you placed in service that year unless you elect out for the whole class.
• If the practice or shop is an S corp or partnership, the 179 limits apply at the entity and again for each owner.
• A California individual filer gets no state bonus, and California caps Section 179 at $25,000 (2025 FTB 3885A instructions).

Would a tenant ever depreciate a build-out over 15 years?

Rarely, but it happens. If you skip Section 179 and elect out of bonus for the 15-year class, qualified improvement property is depreciated straight line over 15 years. The election out covers every 15-year asset you placed in service that year and can be revoked only with IRS consent, so it’s a deliberate choice.

The usual reason is a year where a full write-off would be wasted. Section 179 can’t exceed taxable income from your active businesses, and a bonus-driven loss for an individual owner can run into the excess business loss limit ($256,000, or $512,000 joint, for 2026) and the 80% cap on NOL carryforwards. Watch the definition too. Enlargements, elevators and escalators, and internal structural framework aren’t QIP, and nonresidential building property is 39-year straight line with no bonus, so there’s no expensing choice for those costs.

This guide is general information, not tax advice for your specific situation. Which points apply, and how, depends on your facts.