Meaning
Customized alterations made to a commercial rental space to suit the specific needs of an occupying business enhance the utility of the property. The cost of tenant improvements is often shared or offset by an allowance provided by the landlord under the lease terms. These modifications include installing new walls, specialized lighting, flooring and plumbing fixtures.
Property Modification
Landlords approve the plans for these physical changes to ensure they do not compromise the structural integrity of the building. By allowing the tenant to customize the space, the landlord secures a longer lease commitment from the business. This customization also increases the likelihood that the tenant will renew their lease at the end of the term.
Allowance Allocation
Leases often specify a maximum dollar amount per square foot that the landlord will pay toward the customization of the space. The tenant must submit invoices and proof of completed work to receive the allowance.
Asset Depreciation
Costs incurred for these property modifications are capitalized and depreciated over the shorter of the useful life of the assets or the lease term. This accounting treatment affects the tax liabilities of the party that paid for the work. The ownership of the modifications typically reverts to the landlord when the lease ends.
