# Improvements to Leasehold Property: Tenant's Tax Guide Published: 2026-04-19 Author: Warren Team URL: https://www.heywarren.com/blog/leasehold-improvements --- You signed a five-year office lease, and now your landlord is handing you raw concrete and a stub-out for plumbing. Welcome to the world of build-outs, where your accountant and your CFO are about to argue about depreciation schedules for the next sixty months. Improvements to leasehold property, the walls, lighting, HVAC ducts, and custom millwork you install in space you don't own, sit in an awkward corner of the tax code and the [GAAP](https://www.fasb.org/) rulebook. They look like fixed assets. They walk like fixed assets. But they revert to your landlord the day your lease ends, which makes them feel disposable. Most small business tenants either capitalize the wrong things, miss thousands in bonus depreciation, or expense items that the [IRS](https://www.irs.gov/) expects on the balance sheet. Either mistake costs real cash. This guide walks you through how leasehold improvements work under ASC 842, how MACRS treats qualified improvement property, how to handle a Tenant Improvement Allowance from your landlord, and how to book a clean worked example. By the end, you'll know exactly what to capitalize, what to expense, and how to amortize the rest. I've worked through these schedules for retail, office, and industrial tenants, the rules look complicated but follow a clear pattern. ## What Are Leasehold Improvements? Leasehold improvements are permanent additions or modifications a tenant makes to leased real estate to fit the space for its business operations. They include framed walls, drop ceilings, dedicated HVAC, lighting, flooring, and built-in cabinetry. The tenant pays for the work, capitalizes the cost, and amortizes it over the shorter of the asset's useful life or the remaining lease term. The defining characteristic of a leasehold improvement is that it becomes physically attached to the property. Once installed, the tenant cannot remove the improvement without damaging the building or the asset itself. That permanence triggers capitalization rather than expensing. Movable assets, desks, computers, freestanding shelving, are not leasehold improvements. They stay with the tenant and depreciate on their own schedules under MACRS. Common categories of LHI include: - **Interior partitions and walls**, drywall, glass office fronts, demising walls - **Flooring**, carpet tile, LVT, polished concrete, custom hardwood - **HVAC**, supplemental cooling, duct extensions, VAV boxes - **Lighting and electrical**, recessed cans, track lighting, dedicated circuits, conference room dimming - **Plumbing**, break-room sinks, dishwashers, ADA restroom retrofits - **IT cabinetry and cabling**, server closets, structured Cat6, fiber backbone - **Millwork and built-ins**, reception desks, built-in benches, custom shelving - **Signage**, interior wayfinding, lobby brand walls ![Tenant improvements timeline from build-out through reversion](data:image/svg+xml;base64,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) ## Capitalize or Expense? The GAAP Rule Under U.S. GAAP, you capitalize improvements to leasehold property when they extend the useful life of the leased space or add new functionality. You expense routine repairs and maintenance immediately. The dividing line is whether the work creates a long-lived asset or simply maintains the existing condition. A new partition wall, a fresh HVAC unit, or a custom millwork reception desk all clear the capitalization bar. Patching drywall, replacing a broken light bulb, or recarpeting a worn-out section of an existing floor generally do not. The IRS uses a similar framework through the tangible property regulations, which lean on the BAR test, Betterment, Adaptation, or Restoration. If your spend triggers any one, you capitalize. Once capitalized, the LHI sits on your balance sheet as a fixed asset. You amortize it on a straight-line basis over the shorter of: 1. The remaining lease term (including renewal options you are reasonably certain to exercise), or 2. The asset's economic useful life. Lease term almost always wins for tenants on commercial leases shorter than ten years. A $50,000 server room build inside a five-year lease amortizes at $10,000 per year, not over the equipment's 10- to 15-year physical life. ## MACRS, QIP, and Bonus Depreciation For tax purposes, leasehold improvements that meet the definition of Qualified Improvement Property (QIP) depreciate over 15 years using straight-line MACRS, and they qualify for bonus depreciation. QIP is any improvement to the interior of a nonresidential building placed in service after the building was first placed in service, excluding enlargements, elevators, escalators, and structural framework. ![Bonus depreciation on QIP drops 20 points per year from 2023 through 2026, reaching zero in 2027 absent new legislation.](data:image/svg+xml,%3Csvg%20xmlns%3D%22http%3A%2F%2Fwww.w3.org%2F2000%2Fsvg%22%20viewBox%3D%220%200%20800%20149%22%20width%3D%22800%22%20height%3D%22149%22%20role%3D%22img%22%3E%3Ctitle%3ETimeline%3C%2Ftitle%3E%3Crect%20width%3D%22100%25%22%20height%3D%22100%25%22%20fill%3D%22%23f8fafc%22%2F%3E%3Cline%20x1%3D%22120%22%20y1%3D%2255%22%20x2%3D%22680%22%20y2%3D%2255%22%20stroke%3D%22%23cbd5e1%22%20stroke-width%3D%223%22%2F%3E%3Ccircle%20cx%3D%22120%22%20cy%3D%2255%22%20r%3D%2224%22%20fill%3D%22white%22%20stroke%3D%22%23cbd5e1%22%20stroke-width%3D%222%22%2F%3E%3Ctext%20x%3D%22120%22%20y%3D%2260%22%20text-anchor%3D%22middle%22%20font-family%3D%22system-ui%2C-apple-system%2Csans-serif%22%20font-size%3D%2215%22%20font-weight%3D%22700%22%20fill%3D%22%230f172a%22%3E1%3C%2Ftext%3E%3Ctext%20x%3D%22120%22%20y%3D%22101%22%20text-anchor%3D%22middle%22%20font-family%3D%22system-ui%2C-apple-system%2Csans-serif%22%20font-size%3D%2212%22%20font-weight%3D%22600%22%20fill%3D%22%230f172a%22%3E2023%3C%2Ftext%3E%3Ctext%20x%3D%22120%22%20y%3D%22119%22%20text-anchor%3D%22middle%22%20font-family%3D%22system-ui%2C-apple-system%2Csans-serif%22%20font-size%3D%2210%22%20fill%3D%22%2364748b%22%3E80%25%3C%2Ftext%3E%3Ccircle%20cx%3D%22260%22%20cy%3D%2255%22%20r%3D%2224%22%20fill%3D%22white%22%20stroke%3D%22%23cbd5e1%22%20stroke-width%3D%222%22%2F%3E%3Ctext%20x%3D%22260%22%20y%3D%2260%22%20text-anchor%3D%22middle%22%20font-family%3D%22system-ui%2C-apple-system%2Csans-serif%22%20font-size%3D%2215%22%20font-weight%3D%22700%22%20fill%3D%22%230f172a%22%3E2%3C%2Ftext%3E%3Ctext%20x%3D%22260%22%20y%3D%22101%22%20text-anchor%3D%22middle%22%20font-family%3D%22system-ui%2C-apple-system%2Csans-serif%22%20font-size%3D%2212%22%20font-weight%3D%22600%22%20fill%3D%22%230f172a%22%3E2024%3C%2Ftext%3E%3Ctext%20x%3D%22260%22%20y%3D%22119%22%20text-anchor%3D%22middle%22%20font-family%3D%22system-ui%2C-apple-system%2Csans-serif%22%20font-size%3D%2210%22%20fill%3D%22%2364748b%22%3E60%25%3C%2Ftext%3E%3Ccircle%20cx%3D%22400%22%20cy%3D%2255%22%20r%3D%2224%22%20fill%3D%22white%22%20stroke%3D%22%23cbd5e1%22%20stroke-width%3D%222%22%2F%3E%3Ctext%20x%3D%22400%22%20y%3D%2260%22%20text-anchor%3D%22middle%22%20font-family%3D%22system-ui%2C-apple-system%2Csans-serif%22%20font-size%3D%2215%22%20font-weight%3D%22700%22%20fill%3D%22%230f172a%22%3E3%3C%2Ftext%3E%3Ctext%20x%3D%22400%22%20y%3D%22101%22%20text-anchor%3D%22middle%22%20font-family%3D%22system-ui%2C-apple-system%2Csans-serif%22%20font-size%3D%2212%22%20font-weight%3D%22600%22%20fill%3D%22%230f172a%22%3E2025%3C%2Ftext%3E%3Ctext%20x%3D%22400%22%20y%3D%22119%22%20text-anchor%3D%22middle%22%20font-family%3D%22system-ui%2C-apple-system%2Csans-serif%22%20font-size%3D%2210%22%20fill%3D%22%2364748b%22%3E40%25%3C%2Ftext%3E%3Ccircle%20cx%3D%22540%22%20cy%3D%2255%22%20r%3D%2224%22%20fill%3D%22%232563eb%22%20stroke%3D%22%232563eb%22%20stroke-width%3D%223%22%2F%3E%3Ctext%20x%3D%22540%22%20y%3D%2260%22%20text-anchor%3D%22middle%22%20font-family%3D%22system-ui%2C-apple-system%2Csans-serif%22%20font-size%3D%2215%22%20font-weight%3D%22700%22%20fill%3D%22white%22%3E4%3C%2Ftext%3E%3Ctext%20x%3D%22540%22%20y%3D%22101%22%20text-anchor%3D%22middle%22%20font-family%3D%22system-ui%2C-apple-system%2Csans-serif%22%20font-size%3D%2212%22%20font-weight%3D%22600%22%20fill%3D%22%230f172a%22%3E2026%3C%2Ftext%3E%3Ctext%20x%3D%22540%22%20y%3D%22119%22%20text-anchor%3D%22middle%22%20font-family%3D%22system-ui%2C-apple-system%2Csans-serif%22%20font-size%3D%2210%22%20fill%3D%22%2364748b%22%3E20%25%3C%2Ftext%3E%3Ccircle%20cx%3D%22680%22%20cy%3D%2255%22%20r%3D%2224%22%20fill%3D%22white%22%20stroke%3D%22%23cbd5e1%22%20stroke-width%3D%222%22%2F%3E%3Ctext%20x%3D%22680%22%20y%3D%2260%22%20text-anchor%3D%22middle%22%20font-family%3D%22system-ui%2C-apple-system%2Csans-serif%22%20font-size%3D%2215%22%20font-weight%3D%22700%22%20fill%3D%22%230f172a%22%3E5%3C%2Ftext%3E%3Ctext%20x%3D%22680%22%20y%3D%22101%22%20text-anchor%3D%22middle%22%20font-family%3D%22system-ui%2C-apple-system%2Csans-serif%22%20font-size%3D%2212%22%20font-weight%3D%22600%22%20fill%3D%22%230f172a%22%3E2027%3C%2Ftext%3E%3Ctext%20x%3D%22680%22%20y%3D%22119%22%20text-anchor%3D%22middle%22%20font-family%3D%22system-ui%2C-apple-system%2Csans-serif%22%20font-size%3D%2210%22%20fill%3D%22%2364748b%22%3E0%25%3C%2Ftext%3E%3C%2Fsvg%3E) *Bonus depreciation on QIP drops 20 points per year from 2023 through 2026, reaching zero in 2027 absent new legislation.* The Tax Cuts and Jobs Act of 2017 originally fumbled the QIP definition, leaving it stuck on a 39-year schedule. The CARES Act fixed the drafting error in 2020 and made the change retroactive to 2018. Today QIP recovers over 15 years on the alternative depreciation system, and tenants can claim bonus depreciation in the year the property is placed in service. Bonus depreciation has been phasing down since 2023: - 2023: 80% - 2024: 60% - 2025: 40% - 2026: 20% - 2027: 0% (absent legislation) For a $200,000 office build-out placed in service in 2026, you'd take $40,000 of bonus depreciation immediately, then depreciate the remaining $160,000 over 15 years. Tenants who miss this election leave real money on the table, and can usually fix the omission with a Form 3115 change in accounting method. ![Typical leasehold improvement cost breakdown by category](data:image/svg+xml;base64,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) ## Tenant Improvement Allowance Under ASC 842 A Tenant Improvement Allowance (TIA) is cash or credit your landlord contributes toward your build-out, typically expressed as dollars per rentable square foot. Under ASC 842, the TIA reduces the lessee's right-of-use (ROU) asset at lease commencement when the landlord pays the tenant directly or reimburses construction costs. ![How a $200K build-out net of an $80K tenant improvement allowance becomes a $120K capitalized asset amortized over the lease term.](data:image/svg+xml,%3Csvg%20xmlns%3D%22http%3A%2F%2Fwww.w3.org%2F2000%2Fsvg%22%20viewBox%3D%220%200%20875%20125%22%20width%3D%22875%22%20height%3D%22125%22%20role%3D%22img%22%3E%3Ctitle%3EFlow%20diagram%3C%2Ftitle%3E%3Crect%20width%3D%22100%25%22%20height%3D%22100%25%22%20fill%3D%22%23f8fafc%22%2F%3E%3Crect%20x%3D%2230%22%20y%3D%2225%22%20width%3D%22170%22%20height%3D%2275%22%20rx%3D%2210%22%20fill%3D%22white%22%20stroke%3D%22%232563eb%22%20stroke-width%3D%222%22%2F%3E%3Ctext%20x%3D%22115%22%20y%3D%2258.5%22%20text-anchor%3D%22middle%22%20font-family%3D%22system-ui%2C-apple-system%2Csans-serif%22%20font-size%3D%2214%22%20font-weight%3D%22600%22%20fill%3D%22%230f172a%22%3EGross%20Cost%3C%2Ftext%3E%3Ctext%20x%3D%22115%22%20y%3D%2278.5%22%20text-anchor%3D%22middle%22%20font-family%3D%22system-ui%2C-apple-system%2Csans-serif%22%20font-size%3D%2211%22%20fill%3D%22%2364748b%22%3E%24200%2C000%3C%2Ftext%3E%3Cline%20x1%3D%22205%22%20y1%3D%2262.5%22%20x2%3D%22237%22%20y2%3D%2262.5%22%20stroke%3D%22%2364748b%22%20stroke-width%3D%222%22%2F%3E%3Cpolygon%20points%3D%22244%2C62.5%20235%2C57.5%20235%2C67.5%22%20fill%3D%22%2364748b%22%2F%3E%3Crect%20x%3D%22245%22%20y%3D%2225%22%20width%3D%22170%22%20height%3D%2275%22%20rx%3D%2210%22%20fill%3D%22white%22%20stroke%3D%22%232563eb%22%20stroke-width%3D%222%22%2F%3E%3Ctext%20x%3D%22330%22%20y%3D%2258.5%22%20text-anchor%3D%22middle%22%20font-family%3D%22system-ui%2C-apple-system%2Csans-serif%22%20font-size%3D%2214%22%20font-weight%3D%22600%22%20fill%3D%22%230f172a%22%3ELess%20TIA%3C%2Ftext%3E%3Ctext%20x%3D%22330%22%20y%3D%2278.5%22%20text-anchor%3D%22middle%22%20font-family%3D%22system-ui%2C-apple-system%2Csans-serif%22%20font-size%3D%2211%22%20fill%3D%22%2364748b%22%3E%E2%88%92%2480%2C000%3C%2Ftext%3E%3Cline%20x1%3D%22420%22%20y1%3D%2262.5%22%20x2%3D%22452%22%20y2%3D%2262.5%22%20stroke%3D%22%2364748b%22%20stroke-width%3D%222%22%2F%3E%3Cpolygon%20points%3D%22459%2C62.5%20450%2C57.5%20450%2C67.5%22%20fill%3D%22%2364748b%22%2F%3E%3Crect%20x%3D%22460%22%20y%3D%2225%22%20width%3D%22170%22%20height%3D%2275%22%20rx%3D%2210%22%20fill%3D%22white%22%20stroke%3D%22%232563eb%22%20stroke-width%3D%222%22%2F%3E%3Ctext%20x%3D%22545%22%20y%3D%2258.5%22%20text-anchor%3D%22middle%22%20font-family%3D%22system-ui%2C-apple-system%2Csans-serif%22%20font-size%3D%2214%22%20font-weight%3D%22600%22%20fill%3D%22%230f172a%22%3ENet%20LHI%3C%2Ftext%3E%3Ctext%20x%3D%22545%22%20y%3D%2278.5%22%20text-anchor%3D%22middle%22%20font-family%3D%22system-ui%2C-apple-system%2Csans-serif%22%20font-size%3D%2211%22%20fill%3D%22%2364748b%22%3E%24120%2C000%3C%2Ftext%3E%3Cline%20x1%3D%22635%22%20y1%3D%2262.5%22%20x2%3D%22667%22%20y2%3D%2262.5%22%20stroke%3D%22%2364748b%22%20stroke-width%3D%222%22%2F%3E%3Cpolygon%20points%3D%22674%2C62.5%20665%2C57.5%20665%2C67.5%22%20fill%3D%22%2364748b%22%2F%3E%3Crect%20x%3D%22675%22%20y%3D%2225%22%20width%3D%22170%22%20height%3D%2275%22%20rx%3D%2210%22%20fill%3D%22white%22%20stroke%3D%22%232563eb%22%20stroke-width%3D%222%22%2F%3E%3Ctext%20x%3D%22760%22%20y%3D%2258.5%22%20text-anchor%3D%22middle%22%20font-family%3D%22system-ui%2C-apple-system%2Csans-serif%22%20font-size%3D%2214%22%20font-weight%3D%22600%22%20fill%3D%22%230f172a%22%3EAmortize%3C%2Ftext%3E%3Ctext%20x%3D%22760%22%20y%3D%2278.5%22%20text-anchor%3D%22middle%22%20font-family%3D%22system-ui%2C-apple-system%2Csans-serif%22%20font-size%3D%2211%22%20fill%3D%22%2364748b%22%3E%2424K%2Fyr%20%C3%97%205%3C%2Ftext%3E%3C%2Fsvg%3E) *How a $200K build-out net of an $80K tenant improvement allowance becomes a $120K capitalized asset amortized over the lease term.* The mechanics changed materially when ASC 842 replaced ASC 840. Under the old standard, tenants recorded the TIA as deferred rent and amortized it as a reduction of rent expense over the lease term. Under ASC 842, the allowance is treated as a lease incentive that reduces the initial measurement of the ROU asset. The lease [liability](/blog/examples-liabilities) stays the same, but the ROU asset comes onto the books at a smaller number. When the landlord pays for and owns the improvements directly, the work never hits the tenant's books at all. When the tenant pays and the landlord reimburses through the TIA, the tenant nets the reimbursement against the capitalized cost. The remaining out-of-pocket portion is the LHI you depreciate. ![TIA waterfall from gross construction cost to amortized basis](data:image/svg+xml;base64,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) ## Worked Example: $200K Build-Out, 5-Year Lease, $80K TIA Assume your company signs a 60-month lease on 5,000 square feet of office space. The landlord offers a $16 per square foot TIA, totaling $80,000. Your contractor estimates the full build-out at $200,000, including demising walls, supplemental HVAC, lighting, paint, flooring, and a custom reception desk. ![On a $120K net LHI, GAAP amortizes $24K/yr over 5 years while tax bonus depreciation front-loads $48K in year one (2026, 40% bonus on $200K gross QIP).](data:image/svg+xml,%3Csvg%20xmlns%3D%22http%3A%2F%2Fwww.w3.org%2F2000%2Fsvg%22%20viewBox%3D%220%200%20800%20210%22%20width%3D%22800%22%20height%3D%22210%22%20role%3D%22img%22%3E%3Ctitle%3EComparison%3C%2Ftitle%3E%3Crect%20width%3D%22100%25%22%20height%3D%22100%25%22%20fill%3D%22%23f8fafc%22%2F%3E%3Ctext%20x%3D%22230%22%20y%3D%2257.5%22%20text-anchor%3D%22end%22%20font-family%3D%22system-ui%2C-apple-system%2Csans-serif%22%20font-size%3D%2214%22%20font-weight%3D%22600%22%20fill%3D%22%230f172a%22%3EGAAP%20Yr-1%3C%2Ftext%3E%3Crect%20x%3D%22240%22%20y%3D%2225%22%20width%3D%22225%22%20height%3D%2255%22%20rx%3D%226%22%20fill%3D%22%232563eb%22%2F%3E%3Ctext%20x%3D%22477%22%20y%3D%2257.5%22%20font-family%3D%22system-ui%2C-apple-system%2Csans-serif%22%20font-size%3D%2214%22%20font-weight%3D%22700%22%20fill%3D%22%232563eb%22%3E%2424K%3C%2Ftext%3E%3Ctext%20x%3D%22230%22%20y%3D%22152.5%22%20text-anchor%3D%22end%22%20font-family%3D%22system-ui%2C-apple-system%2Csans-serif%22%20font-size%3D%2214%22%20font-weight%3D%22600%22%20fill%3D%22%230f172a%22%3ETax%20Yr-1%3C%2Ftext%3E%3Crect%20x%3D%22240%22%20y%3D%22120%22%20width%3D%22450%22%20height%3D%2255%22%20rx%3D%226%22%20fill%3D%22%237c3aed%22%2F%3E%3Ctext%20x%3D%22702%22%20y%3D%22152.5%22%20font-family%3D%22system-ui%2C-apple-system%2Csans-serif%22%20font-size%3D%2214%22%20font-weight%3D%22700%22%20fill%3D%22%237c3aed%22%3E%2448K%3C%2Ftext%3E%3C%2Fsvg%3E) *On a $120K net LHI, GAAP amortizes $24K/yr over 5 years while tax bonus depreciation front-loads $48K in year one (2026, 40% bonus on $200K gross QIP).* **Step 1, Capitalize the gross cost.** Debit Leasehold Improvements $200,000; credit Cash or Accounts Payable $200,000. **Step 2, Apply the TIA.** When the landlord funds the $80,000, you have two paths under ASC 842. If the TIA is structured as a reimbursement of tenant-owned improvements, you net $80,000 against the LHI asset. The capitalized basis becomes $120,000. If the allowance is structured as a general lease incentive, you reduce the ROU asset by $80,000 instead and keep the full $200,000 on the LHI line. **Step 3, Amortize.** The $120,000 net LHI amortizes straight-line over 60 months, or $2,000 per month / $24,000 per year. Book Depreciation Expense $2,000; credit [Accumulated Depreciation](/blog/accumulated-depreciation) $2,000 each month. **Step 4, Apply tax depreciation separately.** For tax, the $200,000 (the full QIP amount, before TIA netting under most structures) qualifies for bonus depreciation in the placed-in-service year. The remainder depreciates over 15 years on a straight-line MACRS schedule. Your book and tax basis will diverge, generating a deferred tax liability you track on Schedule M. **Step 5, Reversion.** At month 60, the lease ends. The improvements physically remain in the space and revert to the landlord. Your accumulated depreciation has fully written off the asset, so there's nothing left on the balance sheet. If you exit early, write off the remaining net book value as a loss on disposal. ## Common Mistakes Tenants Make The biggest errors are conceptual rather than computational, and they show up in nearly every audit I've seen. **Mis-classifying repairs as LHI.** Patching drywall after moving a desk, replacing a few ceiling tiles, or repainting a meeting room are repairs and maintenance, expense them. Capitalizing routine items inflates assets and understates current-year deductions. **Using the wrong amortization period.** Tenants frequently amortize over the IRS's 15-year QIP life for book purposes. GAAP requires the shorter of useful life or remaining lease term. A five-year lease drives a five-year book schedule, full stop. **Missing bonus depreciation.** Many CPAs default to straight-line MACRS without testing the QIP and bonus eligibility. For 2025-placed property at 40% bonus, that's $80,000 of immediate deduction on a $200,000 build the tenant otherwise spreads over 15 years. **Ignoring TIA accounting.** Some tenants book the TIA as miscellaneous income on day one, which is wrong under both old and new standards. Under ASC 842, the allowance reduces the ROU asset or the LHI basis depending on structure, never current-period revenue. **Forgetting renewal options in lease term.** If you are reasonably certain to exercise a five-year renewal option, the lease term for amortization purposes is ten years, not five. Test this annually and reassess if facts change. **Failing to write off remaining basis on early termination.** If you sublease, terminate, or relocate, any remaining LHI book value becomes an immediate loss. Don't leave dead assets on the balance sheet. ## Conclusion Improvements to leasehold property sit at the intersection of real estate, accounting, and tax, three disciplines that rarely speak the same language. Get the capitalization right, layer in your Tenant Improvement Allowance correctly under ASC 842, and claim the QIP bonus depreciation you're entitled to under MACRS. Five takeaways to anchor on: 1. **Capitalize permanent improvements; expense routine repairs.** The BAR test, Betterment, Adaptation, Restoration, is your filter. 2. **Amortize over the shorter of useful life or remaining lease term.** For most commercial tenants, lease term wins. 3. **Net the TIA against the LHI asset or the ROU asset depending on structure.** Never book it as income. 4. **Claim QIP bonus depreciation while it's still available.** The phase-down is real, and a Form 3115 can recover missed years. 5. **Write off remaining basis on early termination.** Don't leave ghost assets on the books. As bonus depreciation continues phasing down through 2027, the tax cost of getting leasehold improvements wrong is rising every year. Tenants negotiating new leases in 2026 should model the post-bonus tax math before signing, the after-tax cost of a build-out is meaningfully higher than it was three years ago, and that should change how you negotiate TIA dollars per square foot. Ready to put this knowledge to work? Try Warren, your AI financial advisor, get personalized, conflict-free guidance at heywarren.com --- ## Related Reading **More from Warren**: - [Mill Rate Explained: Property Tax Math Every Buyer Needs](/blog/mill-rate) - [OpCo PropCo: How Businesses Split Operations and Real Estate for Tax and Capital Efficiency](/blog/opco-propco) - [REMIC Explained: Tax Structure Behind US Mortgage MBS](/blog/remic) **Authoritative sources**: - [Consumer Financial Protection Bureau, Owning a Home](https://www.consumerfinance.gov/owning-a-home/) - [HUD, Homeownership](https://www.hud.gov/topics/buying_a_home) - [IRS, Real Estate Tax Center](https://www.irs.gov/businesses/small-businesses-self-employed/real-estate-tax-center)