Tenant Improvement Allowance Accounting

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Tenant improvement allowances are common in commercial leases, especially when a tenant needs to customize a space before moving in. For landlords, these allowances can help attract quality tenants, reduce vacancy, and make a property more competitive. However, they also create important accounting, tax, and lease administration considerations.

A tenant improvement allowance, often called a TI allowance or lease improvement allowance, is money a landlord provides to help pay for improvements to a leased space. These improvements may include walls, flooring, lighting, electrical work, plumbing, HVAC systems, and other build-out costs.

While the concept is simple, the accounting treatment can be more complex. The way a tenant improvement allowance is handled may depend on when the allowance is paid, who owns the improvements, whether the allowance is fixed or contingent, and how the lease is structured under ASC 842.

This guide explains what landlords need to know about tenant improvement allowance accounting, including how allowances are calculated, what costs are usually covered, how payments are made, and how ASC 842 may apply.

What is a tenant improvement allowance?

A TI allowance is money provided by the landlord to a tenant to help fund any improvements to space. Fast tenant improvement allowances can also be used to pay for costs associated with moving to the rented property.

Tenant improvement allowances are common when a commercial space needs to be customized for a tenant’s business. For example, an office tenant may need private offices, meeting rooms, lighting, flooring, and updated electrical work.

A retail tenant may need fitting rooms, display areas, counters, or other layout changes.

The allowance may be provided as a lump sum or calculated on a per-square-foot basis.

For example, if a landlord offers a $40 per-square-foot tenant improvement allowance for a 1,500-square-foot space, the total allowance would be $60,000.

Tenant improvement allowances are often used to:

Help tenants prepare a space for business operations
Make a property more attractive to potential tenants
Reduce vacancy
Support longer lease terms
Improve the long-term value or usability of the property

What costs are covered by a tenant improvement allowance?

Tenant improvement allowances are usually meant to cover permanent improvements to the leased space. These are often called hard costs because they are tied directly to construction or physical upgrades.

However, not every expense related to a move or build-out is covered. Some costs may only be reimbursed if they are clearly included in the lease.

Usually Covered	Sometimes Covered	Usually Not Covered
Interior walls and framing	Architectural design	Furniture
Doors	Engineering	Office equipment
Flooring	Permits	Computers and technology hardware
Ceilings	Construction management	Inventory
Lighting	Project management fees	Moving expenses
Electrical wiring	Inspections	Decorative items
Plumbing	Signage, if approved	Operating expenses
Restrooms	Specialty build-out costs	Trade fixtures, unless stated in the lease
HVAC systems	Legal or professional fees	Branding materials, unless approved

How much is a typical tenant improvement allowance?

The amount of a tenant improvement allowance depends on the property, the market, the condition of the space, and the lease terms.

A shell space that requires a full build-out may need a higher allowance than a second-generation space that already has usable walls, flooring, lighting, restrooms, and HVAC systems.

The allowance may also vary based on:

Property type
Property class
Tenant creditworthiness
Lease term length
Market conditions
Scope of work
Whether the improvements benefit the landlord long term

The longer the lease term, the more likely a landlord may be willing to provide a larger allowance. This is because the landlord has more time to recover the cost of the allowance through rental income.

How to account for tenant improvement allowances under ASC 842

Under ASC 842, tenant improvement allowances (TIAs) are still classified as incentives, but they are no longer reported as a lease incentive obligation liability to be amortized over the life of the lease. Instead, they are reflected in the initial measurement of the right-of-use asset (ROU asset) and sometimes the lease liability at the inception of the lease, depending on when the allowance is received.

When initially adopting ASC 842, any unamortized lease incentive obligation liabilities are eliminated and reclassified to the new ROU asset’s opening balance. After initial implementation of the new standard, TIAs will continue to be recognized in the ROU asset and potentially lease liabilities.

ASC 842 describes lease incentives as “paid” or “payable” depending on the timing of their receipt. This article uses the same terminology and describes how to account for both types.

Is a tenant improvement allowance a loan?

The typical TI allowance is not a loan that has to be paid back by the tenant. However, there is an amortized TI allowance, which is a combination of a TI and a loan provided by the landlord.

The tenant improvement allowance amortization is a provision in the contract that has to be negotiated between the tenant and the landlord.

An amortized TI provides for additional funds needed to complete the renovations. It allows the tenant to borrow money with interest from the landlord. The loan is like a bank loan where tenants have to pay the amortization over the term of the lease.

How are tenant improvement allowances paid?

Tenant improvement allowances are often paid as reimbursements rather than upfront payments.

A common process may look like this:

The tenant completes approved improvements.
The tenant pays contractors or vendors.
The tenant submits invoices, receipts, lien waivers, and other required documents.
The landlord reviews the documentation.
The landlord reimburses eligible costs up to the allowance amount.

Some landlords may pay contractors directly or apply the allowance as a rent credit. The lease should explain when the allowance is available, what documents are required, whether partial reimbursements are allowed, and what happens if the tenant does not use the full allowance.

This documentation is important because it supports both lease administration and accounting.

Accounting for tenant improvement allowances

Under ASC 842, tenant improvement allowances are generally treated as lease incentives. However, the accounting treatment depends on the terms of the lease and the timing of the allowance.

Important questions include:

Is the allowance paid before lease commencement?
Is the allowance paid at lease commencement?
Is the allowance payable after commencement?
Is the allowance contingent on future construction costs?
Who owns the improvements?
Does the landlord or tenant control the improvements?
Is the payment tied to future rent?
Is the allowance fixed or variable?

Under ASC 842, tenant improvement allowances are no longer recorded as a lease incentive obligation that is amortized over the life of the lease. Instead, they are generally reflected in the initial measurement of the right-of-use asset and, in some cases, the lease liability at lease commencement.

Because the treatment may vary based on the structure of the arrangement, landlords should review each lease carefully.

Landlord owns the improvements

When the landlord pays for the renovation and tenants supervise the work or when the landlord pays and oversees the improvement, then it is the landlord who owns the improvements.

In this scenario, the landlord is required to record the improvements as a fixed asset and then depreciate the value of the improvements over a specified period.

For example, if the improvement costs a total of $10,000, the landlord will use this figure and divide it throughout the lease. The figure from this division would be subtracted from the rental income annually.

The length of time depends on the classification of the rental property: residential or non-residential. Generally, residential property is depreciated for 27.5 years and a non-residential property is depreciated over 39 years. However, costs that are not covered by the TI allowance such as fixtures, furniture, and equipment are depreciated over 7 years.

The landlords will be depreciating the cost of the improvements over the lease period. If there is a new tenant who doesn’t require any improvements to the property, then the landlord can simply carry on with the depreciation schedule until the value of the improvements has been exhausted.

If the property was damaged or destroyed, then the landlord has to write off the remaining undepreciated balance of the asset that will appear as a loss in the income statement.

Tenant owns the improvements

If the tenants provided the funds for the majority of improvements, then it is the tenant who owns the improvements. In this scenario, the tenant will record the TI allowance received as an incentive. The amount spent on improvement will be amortized over the period of the rental term.

In cases when the amortization period is longer than the rental period, then the tenant is required to write off the remaining amount.

Flow-through arrangement

In a flow-through arrangement, the tenant may pay for the improvements and receive reimbursement from the landlord.

For the tenant: The reimbursement may be treated as a lease incentive or as a reduction of the right-of-use asset, depending on the lease terms and timing of the payment.
For the landlord: The payment may be treated as a lease incentive, a capitalized improvement, or another form of lease-related cost depending on who owns and controls the improvements.

These arrangements should be reviewed carefully because the accounting depends on the substance of the transaction, not only the payment flow.

Journal entries depend on the lease structure

The journal entries for tenant improvement allowances depend on the lease structure.

The most common scenarios include:

Tenant improvement allowances paid at or before commencement of the lease
Tenant improvement allowances payable after commencement of the lease
Tenant improvement allowances neither paid nor payable at commencement of the lease

Each scenario can affect the right-of-use asset, lease liability, lease income, and expense recognition differently.

Tenant improvement allowances paid at or before commencement of the lease

When a tenant improvement allowance is paid at or before the commencement of the lease, it is generally considered in the initial measurement of the lease.

From the tenant’s perspective, the allowance may reduce the opening balance of the right-of-use asset. The lease liability is generally measured as the present value of future lease payments.

For example:

Present value of lease payments: $150,000
Tenant improvement allowance paid at commencement: $20,000
Right-of-use asset before other adjustments: $130,000

simplified tenant-side journal entry may look like this:

Debit Cash: $20,000
Debit Right-of-Use Asset: $130,000
Credit Lease Liability: $150,000

*This is an example: Actual accounting may depend on prepaid rent, initial direct costs, restoration obligations, and lease classification.

Under ASC 842, TIAs are accounted for as a direct adjustment to the right-of-use (ROU) asset’s opening balance. The ROU asset is the asset that a lessee obtains by entering into a lease. It is calculated as the present value of the lease payments.

When a TIA is paid at or before the commencement of the lease, it reduces the ROU asset’s opening balance. This is because the lessee is essentially receiving a payment from the landlord that reduces the amount of money that they will have to pay over the life of the lease.

In the month/period of transition to ASC 842, any unamortized balance of a TIA is debited to remove the lease incentive liability from the balance sheet and reclassed to the ROU asset’s opening balance with a credit. This journal entry ensures that the ROU asset is accurately reflected on the balance sheet after the transition to ASC 842.

After the transition, TIAs received at lease commencement are recognized as a debit to cash and adjust the initial ROU asset recognized. The remaining line items to record a new lease are a credit to the lease liability and a debit to the ROU asset, adjusted to equal the initial liability balance less the TIA received.

Tenant improvement allowances payable after the commencement of the lease

When TIAs are paid after the commencement of the lease, they are factored into both the lease liability and right-of-use (ROU) asset measurement. The lease liability is calculated as the present value of all future payments, including those received for the allowance. The ROU asset is the asset that a lessee obtains by entering into a lease. It is calculated as the present value of the lease payments.

The payments for improvements will be reflected in the periods they are expected to be received during the lease term and netted with the rent payments for that period. This means that the lease liability will be lower due to factoring in the expected cash receipts, and subsequently, the ROU asset balance will also be lower.

Tenant improvement allowances neither paid nor payable at the commencement of the lease

ASC 842 does not provide specific guidance on how to account for tenant improvement allowances (TIAs) that are neither paid nor payable at the commencement of the lease. This can make it difficult for lessees to determine how to properly record these allowances in their financial statements.

Here are two approaches to accounting for TIAs that are not paid or payable at the commencement of the lease:

Maximum reimbursement approach: This approach assumes that the lessee is reasonably certain to incur the maximum amount of reimbursable costs under the lease. The maximum amount of the TIA is then treated as an incentive payable, which is recognized through a reduction of the lease liability and right-of-use (ROU) asset.
Actual reimbursement approach: This approach waits until the reimbursable costs have actually been incurred before reducing the ROU asset and lease liability. The reduction of the ROU asset is then recognized prospectively over the remainder of the lease term.

The best approach to accounting for TIAs that are not paid or payable at the commencement of the lease will depend on the specific facts and circumstances of the lease. However, the maximum reimbursement approach is generally considered to be the most conservative and straightforward approach.