Depreciable Life of Leasehold Improvements: 39 Years vs. Bonus

The depreciable life of leasehold improvements is 15 years for interior work that meets the definition of qualified improvement property (QIP), and 39 years for anything that doesn’t. Because QIP is 15-year MACRS property, it also qualifies for 100% bonus depreciation, which the One Big Beautiful Bill Act permanently restored for property acquired after January 19, 2025. In practical terms, most tenant build-out costs placed in service today can be deducted in full in year one, while structural work, exterior work, elevators, and building enlargements remain on the slow 39-year schedule.¹

What Counts as Qualified Improvement Property

QIP is any improvement a taxpayer makes to the interior of a non-residential building after the building was first placed in service. The building doesn’t need to be leased; owned buildings qualify too. For tenants customizing rented office, retail, or industrial space, the category captures most typical build-out costs: flooring, dropped ceilings, interior partition walls, lighting systems, millwork, and comparable finishes.¹

Three categories of spending are excluded from QIP regardless of who pays for them. Building enlargements — adding square footage, a new wing, or a floor — do not qualify. Elevators and escalators are excluded even when the work is entirely interior. And work on the internal structural framework (load-bearing walls, columns, foundations, structural beams) also falls outside QIP.¹

Under the general depreciation system, QIP is depreciated straight-line over 15 years using a half-year convention, so the asset is treated as placed in service at the midpoint of the year regardless of the actual date. That produces a half-year’s depreciation in year one and again in year sixteen.¹

One point that surprises tenants: the recovery period doesn’t shrink to match the lease. A tenant with a five-year lease who spends $200,000 on qualifying interior work still has a 15-year asset for tax purposes. The old pre-1987 rule that tied the depreciation period to the lease term no longer applies for federal taxes.

When the 39-Year Life Applies

Any improvement that fails the QIP definition is depreciated over 39 years, straight-line, using a mid-month convention. That covers the three excluded categories above, plus any exterior work, since QIP is interior-only.¹

Several building systems that feel like interior work also land in 39-year territory: roofing, HVAC, fire suppression and alarm systems, and security systems. These specific items can still be expensed under Section 179, which is often the way businesses avoid the 39-year schedule on major mechanical upgrades.¹

Misclassifying an excluded item as QIP overstates the first-year deduction and creates audit exposure, so keeping a clear cost breakdown between structural and non-structural work matters from the start of the project.

Who Actually Takes the Depreciation

The right to depreciate a leasehold improvement belongs to whoever holds the incidents of ownership over that improvement. In most tenant build-outs, the tenant pays for the work, bears the risk if it loses value, and controls it during the lease. The tenant depreciates it. A landlord who funds the work and keeps ownership depreciates it on the landlord’s return instead.¹

The IRS weighs who holds legal title, who pays for maintenance, who carries property tax obligations, and who suffers the economic loss if the improvement is destroyed or becomes obsolete. When those indicators split, the analysis gets fact-intensive, but the broad rule holds: if you paid and you bear the downside, you take the depreciation.¹

100% Bonus Depreciation After July 2025

The One Big Beautiful Bill Act, signed on July 4, 2025, permanently restored 100% first-year bonus depreciation for qualifying property acquired after January 19, 2025. QIP qualifies because it’s 15-year MACRS property. A business that acquires and places QIP in service after that acquisition date can deduct the entire cost in year one.²

This replaces the phase-down that had been running under the original TCJA schedule: 80% for 2023, 60% for 2024, 40% for 2025, 20% for 2026, and zero after that. The phase-down no longer applies to property acquired after January 19, 2025.³

Watch the acquisition date carefully. It’s not the placed-in-service date that controls eligibility for the 100% rate. If your business contracted for and began a build-out in 2024 but doesn’t place it in service until 2026, the old phase-down still applies because the property was acquired before January 20, 2025. In that case, the bonus rate is 20% based on the 2026 placed-in-service year. QIP acquired after January 19, 2025 and placed in service in 2026 or later gets the full 100%.

For the first tax year ending after January 19, 2025, a taxpayer can elect to take only 40% bonus depreciation instead of 100%. That election exists for businesses that would rather spread deductions across multiple years than take the full write-off up front.³

Section 179 as an Alternative

QIP also qualifies for Section 179 expensing. For tax years beginning in 2025, the maximum Section 179 deduction is $2,500,000, phasing out dollar-for-dollar once qualifying property placed in service exceeds $4,270,000. The 2026 cap is projected at $2,560,000 with the phase-out starting at $4,090,000.¹

Two practical differences from bonus depreciation. Section 179 can’t exceed taxable income for the year, so it can’t create or increase a net operating loss. And it has an annual dollar cap, while bonus depreciation has no dollar ceiling. With 100% bonus back on the table permanently, Section 179 is most useful when you want precise control over how much to deduct in the current year, or when you’re expensing items like HVAC and roofing that don’t qualify as QIP but do qualify for Section 179.

When ADS Forces 20 Years

Some businesses have to use the Alternative Depreciation System (ADS) instead of the general system. Under ADS, QIP has a 20-year recovery period rather than 15. The most common trigger is a real property trade or business that elects out of the Section 163(j) interest deduction limitation. In exchange for uncapped business interest deductions, those taxpayers depreciate non-residential real property over 40 years, residential rental over 30, and QIP over 20.⁴

Property depreciated under ADS is not eligible for bonus depreciation, so 100% first-year expensing is off the table for businesses that made the election. The 163(j) election is irrevocable, which makes it a permanent trade-off between unlimited interest deductions and slower cost recovery on real property improvements.

Tenant Improvement Allowances

When a landlord provides cash for a tenant to fund a build-out, tax treatment depends on who owns the resulting improvements and whether the arrangement fits the Section 110 safe harbor. Under Section 110, a cash construction allowance received by a retail tenant under a short-term lease (15 years or less) is excluded from the tenant’s income if the money is spent on qualifying non-residential real property improvements that revert to the landlord at the end of the lease.⁵

Section 110 is narrow. It applies only to retail space where the tenant sells goods or services to the general public. Office tenants, medical practices, and warehouse operators can’t use it. The lease must expressly state that the allowance is for constructing or improving the space, and the tenant must spend the money on qualifying improvements within eight and a half months after the close of the tax year in which the allowance was received. Any unspent portion is taxable income.⁵

Outside the Section 110 safe harbor, the treatment turns on ownership. If the tenant holds the benefits and burdens of ownership over the improvements, the allowance is generally taxable income to the tenant in the year received, and the tenant depreciates the improvements. If the landlord retains ownership, the tenant is effectively acting as the landlord’s agent, the allowance isn’t income to the tenant, and the landlord takes the depreciation.

State Conformity

Federal bonus depreciation doesn’t automatically carry over to state income taxes. Many states either decouple entirely from federal bonus rules or conform only partially, so a leasehold improvement that gets a full first-year federal write-off may still need to be depreciated over 15 or 39 years on the state return. That creates a separate state depreciation schedule to maintain.

With 100% federal bonus permanently restored, the gap between federal and state treatment is likely to widen in non-conforming states. Check your state’s current conformity position before assuming the federal deduction translates.

Writing Off What’s Left at Lease End

When a lease ends and the tenant walks away from improvements that revert to the landlord, the tenant has disposed of the asset for tax purposes. If any undepreciated cost remains, the tenant claims an ordinary loss equal to original cost minus depreciation taken through the disposition date. Report it on Form 4797, Part II.⁶

This mostly matters now for improvements placed in service under the old phase-down rates or for 39-year property that isn’t QIP. A tenant who depreciated structural modifications over 39 years and vacates after a ten-year lease could have a substantial remaining basis to deduct.

You don’t have to wait until the lease ends. If you tear out and replace flooring, lighting, or other interior work mid-lease, you can make a partial disposition election under Treasury regulations to treat the removed component as a separate disposed asset. That triggers a loss for the remaining undepreciated cost of the removed portion in the year of replacement.⁷

The election has to be made on a timely filed return, including extensions, for the year of disposition. You take the loss and begin depreciating the replacement improvement as a new, separate asset. Without the election, the old improvement’s undepreciated cost stays on the depreciation schedule even though the physical asset is gone, and you keep recovering phantom costs over the remaining recovery period. This is where many businesses leave money on the table, simply because they don’t know the election exists.⁷

1
Internal Revenue Service. Publication 946 (2025), How To Depreciate Property
2
Internal Revenue Service. One, Big, Beautiful Bill Provisions
3
Internal Revenue Service. Treasury, IRS Issue Guidance on the Additional First Year Depreciation Deduction Amended as Part of the One Big Beautiful Bill
4
Office of the Law Revision Counsel. 26 U.S. Code 168 – Accelerated Cost Recovery System
5
eCFR. 26 CFR 1.110-1 – Qualified Lessee Construction Allowances
6
Internal Revenue Service. Instructions for Form 4797 (2025)
7
eCFR. 26 CFR 1.168(i)-8 – Dispositions of MACRS Property