Tenant improvements are the permanent interior changes made to a commercial rental space so it works for a specific business — new walls, flooring, lighting, wiring, plumbing, and similar built-in modifications inside an office, retail store, or medical suite. You’ll also see them called leasehold improvements. Landlords routinely fund or share these costs as an incentive to sign tenants to longer leases, and how the deal is structured affects taxes, liability, and what the tenant owes when the lease ends.
What Counts as a Tenant Improvement
The category covers the interior of the leased space: walls, ceilings, floors, lighting, plumbing, and electrical systems inside the suite. Anything physically attached to the building’s interior envelope typically qualifies. The building’s core structure does not. Foundation, load-bearing walls, roof, elevators, and shared mechanical systems remain the landlord’s responsibility and fall outside the category.
For federal tax purposes, the IRS calls this “qualified improvement property” (QIP): any improvement to the interior of a nonresidential building placed in service after the building itself was first put into use. QIP excludes building enlargements, elevators or escalators, and changes to the building’s internal structural framework.1Internal Revenue Service. Publication 946 (2025), How To Depreciate Property That tax definition lines up closely with how most commercial leases define the term, and it matters once depreciation comes into play.
Common Examples
The most recognizable work involves building out interior walls and partitions to create private offices, exam rooms, or conference spaces from an open shell. Flooring is close behind: commercial-grade carpet tile, polished concrete, and ceramic tile are standard. Acoustic ceiling systems and recessed lighting get installed to match the look and functional needs of the business.
A large share of the budget usually goes to infrastructure you don’t see. Electrical wiring for data and power. HVAC ductwork routed to new room configurations. Plumbing for breakroom sinks or restroom additions. A medical office might need specialized ventilation and oxygen lines. A restaurant build-out needs grease traps, commercial hoods, and fire suppression systems. The specifics vary by industry, but the common thread is that these modifications become permanently attached to the building.
How They Differ From Trade Fixtures
This distinction trips up a lot of tenants, and getting it wrong can cost real money at the end of a lease. Tenant improvements become part of the real estate; they’re integrated into the building in a way that removing them would damage the structure. Trade fixtures are items a business installs to carry out its specific trade: dental chairs, display cases, server racks, brewing equipment, point-of-sale terminals. The general rule is that tenants can remove trade fixtures before the lease expires, as long as removal doesn’t cause significant damage to the premises.
Courts evaluating the distinction focus on the tenant’s intent at installation and the method of attachment. A custom reception counter bolted into the floor and wired into the building’s electrical system looks permanent. A freestanding desk sitting on the carpet is clearly personal property. The gray area in between is where disputes happen — a walk-in cooler anchored to the floor, for instance. Your lease should spell out which items you can take with you and who pays to repair any damage from removal. If the lease is silent, default rules in most states favor the landlord on anything that looks permanently attached.
Who Pays: Allowances and Turnkey Build-Outs
Landlords and tenants structure the financial side of a build-out in one of two ways, and the choice affects who controls the project, who bears the risk, and who owns the result.
Tenant Improvement Allowance
The most common arrangement is a tenant improvement allowance, or TIA. The landlord commits a fixed dollar amount per square foot. National averages sit in the $20 to $60 range, though Class A office space in major markets can push higher. The tenant manages the design and construction, choosing their own architect, contractors, and materials. If the project costs more than the allowance, the tenant covers the overage out of pocket. If it comes in under, some leases let the tenant apply the leftover to rent or other expenses, though many landlords simply retain the difference.
The details get documented in a “work letter” attached to the lease. A well-drafted work letter covers the allowance amount and what it can be spent on, the design approval process, who pulls permits, how draws against the allowance work, construction timelines, and what happens if the project runs over budget or behind schedule. Tenants who skip the fine print on the work letter often discover too late that architectural fees or permit costs weren’t covered.
Turnkey Build-Out
In a turnkey arrangement, the landlord handles everything. The tenant approves a floor plan and specifications up front, and the landlord delivers a finished space ready for move-in. The tenant avoids managing contractors and dealing with construction delays, but gives up control over material choices and the pace of the work. Landlords favor turnkey deals because they can use existing contractor relationships and keep tighter control over costs. The tradeoff is that turnkey spaces sometimes feel more generic, since landlords have less incentive to spring for premium finishes beyond what the agreed plan requires.
Tax Treatment and Depreciation
The tax benefits attached to tenant improvements are substantial, and the rules shifted when the One, Big, Beautiful Bill became law on July 4, 2025. How you depreciate these costs depends on which deduction method you choose and when the property was placed in service.
100 Percent Bonus Depreciation
Qualified improvement property acquired after January 19, 2025, is eligible for a permanent 100 percent first-year depreciation deduction under the amended rules.2Internal Revenue Service. Treasury, IRS Issue Guidance on the Additional First Year Depreciation Deduction Amended as Part of the One, Big, Beautiful Bill If you complete a $500,000 office build-out in 2026, you can deduct the entire cost in the year the improvements are placed in service rather than spreading it over many years. That’s a significant change from the phaseout that was underway. Bonus depreciation had dropped to 60 percent for 2024 and was headed to zero by 2027 before Congress intervened.
Section 179 Expensing
As an alternative to bonus depreciation, businesses can elect to expense qualified improvement property under Section 179. For tax years beginning in 2026, the maximum Section 179 deduction is $2,560,000, and that ceiling starts phasing out once total qualifying property placed in service exceeds $4,090,000. Qualified real property, which includes QIP, is specifically eligible. Section 179 is especially useful for smaller build-outs where the full cost falls well under the cap.
Standard Depreciation
If neither bonus depreciation nor Section 179 applies, or if a business elects out of both, qualified improvement property is depreciated over a 15-year recovery period using the straight-line method.3Internal Revenue Service. Notice 2026-16 The 15-year period makes QIP eligible for accelerated methods even without bonus depreciation.
Permits and ADA Compliance
Tenant improvements aren’t just a negotiation between landlord and tenant. Local building departments and federal accessibility law both have a say. Permit requirements vary by jurisdiction, but as a general rule, any interior alteration that involves new walls, changes to electrical or plumbing systems, or a change in how the space is used will trigger a building permit. Most jurisdictions also require a final inspection before the space can be occupied.
The ADA side catches tenants off guard more often. When alterations affect a “primary function area” — the main workspace, sales floor, dining room, or exam rooms where the business actually operates — the project triggers a requirement to make the path of travel to that area accessible. That includes the route from the building entrance through corridors to the altered space, plus access to restrooms, drinking fountains, and telephones serving that area.4U.S. Access Board. Chapter 2: Alterations and Additions
There is a cost cap. You’re not required to spend more than 20 percent of the total alteration cost on path-of-travel upgrades. If making the full path accessible would exceed that threshold, you prioritize the most critical elements, typically the entrance, the route to the altered area, and restrooms, and document what was done. In leased buildings, a tenant altering space that only they occupy generally doesn’t trigger path-of-travel obligations for areas the landlord controls, unless the landlord is also making changes.4U.S. Access Board. Chapter 2: Alterations and Additions Still, budgeting for some ADA work is smart practice on any project that touches the layout of a primary function area.
Insurance and Lien Exposure
Two practical risks come with tenant improvement projects that most parties underestimate until something goes wrong.
Insuring the Work
Most commercial leases require the tenant to carry property insurance covering the full replacement cost of all alterations and leasehold improvements within the space, with the landlord named as loss payee. During active construction, a separate builder’s risk policy protects the work in progress against fire, theft, and weather damage. Which party purchases that policy — tenant, landlord, or general contractor — is negotiable and should be spelled out in the work letter. Someone has to carry it, because a standard commercial property policy typically won’t cover work under construction.
Mechanic’s Liens on the Landlord’s Property
When a tenant hires contractors and those contractors don’t get paid, the unpaid party can file a mechanic’s lien. In many states, that lien attaches to the landlord’s property, not just the tenant’s leasehold interest. The risk is highest when the landlord has consented to or actively encouraged the improvements, which is almost always the case when a TI allowance is involved. Courts in most states look at whether the landlord was an “affirmative factor” in procuring the work or stood to benefit from it.
Landlords protect themselves by filing a notice of non-responsibility, which is posted at the property and recorded with the county. The notice tells contractors that the landlord isn’t liable for the tenant’s debts and that collection efforts should be directed at the tenant alone. In states that recognize the procedure, a properly filed notice shields the landlord’s fee interest from liens arising out of the tenant’s project. Tenants should expect landlords to require lien waivers from contractors at each payment milestone as an additional safeguard.
Who Owns the Improvements at Lease End
Here’s the part that surprises tenants who spent heavily on a beautiful build-out: once the improvements are in place, they belong to the landlord. Virtually every commercial lease treats permanently installed improvements as part of the real property. When the lease ends, the improvements stay. The tenant walks away from the custom millwork, the built-in cabinetry, and the upgraded lighting without compensation.
What makes it worse is the restoration clause. Many leases require the tenant to return the space to its original shell condition at the tenant’s expense. That means ripping out partition walls, removing specialty flooring, patching and painting, and hauling away debris. Restoration costs vary depending on how extensively the space was customized, but tenants should expect to budget meaningfully for demolition and remediation. Negotiating the restoration obligation before signing the lease is far cheaper than discovering it at the end of a ten-year term. Some tenants successfully negotiate a cap on restoration costs, an exemption for standard office improvements, or a mutual walk-through process that lets the landlord waive restoration if the existing build-out suits the next tenant.
If the landlord funded the improvements through a TI allowance, there’s a reasonable argument that the landlord shouldn’t also require the tenant to tear them out. That argument doesn’t always win, but it’s leverage worth using, especially if the improvements are relatively generic office finishes rather than something highly specialized.