Executory costs are the ownership expenses bundled into a lease payment that have nothing to do with your right to use the property or equipment: property taxes, insurance premiums, common area maintenance, and scheduled repairs the owner would owe whether or not the asset was leased out. Under ASC 842, these amounts are generally expensed as incurred rather than capitalized into the right-of-use asset and lease liability, but the mechanics of getting them out of the lease payment depend on which of three categories each cost falls into.
What Counts as an Executory Cost
The label shows up most often in commercial real estate and equipment leasing, and the items share one trait: they represent what the owner would pay to maintain the asset regardless of the tenant. When the lease passes those costs to you, your payment is reimbursing the owner, not paying for the right to occupy or use the asset.
- Property taxes, a statutory charge tied to ownership that many leases push to the tenant.
- Insurance premiums covering the landlord’s asset against casualty loss.
- Common area maintenance (CAM) in multi-tenant buildings, covering landscaping, security, cleaning, and utilities for lobbies, parking lots, and other shared spaces.
- Scheduled servicing and repairs on complex leased equipment, such as aircraft engines or specialized manufacturing machinery, where the lessor handles maintenance and bills separately.
These are costs of owning and operating the asset, not payments for the economic value you consume by using it. That distinction drives every accounting decision that follows.
How ASC 842 Sorts Every Dollar in the Lease
The phrase “executory costs” comes from the old lease standard, ASC 840. ASC 842 retired the catch-all label and replaced it with three categories, each with its own treatment.
Lease Components
A lease component is the payment for the right to use a specific underlying asset. In an office lease, that is the base rent for the right to occupy the space. Only the lease component is capitalized as a right-of-use asset with a matching lease liability.
Nonlease Components
A nonlease component is an activity in the contract that transfers a separate good or service to you. CAM is the textbook example: the landlord is performing a service you would otherwise handle yourself. Equipment maintenance services work the same way. Because a real service is being delivered, nonlease components receive an allocation of the total contract price.
Noncomponents
Property taxes and insurance sit in a third category. ASC 842 is explicit that reimbursing the landlord for costs it incurs as owner does not transfer a good or service to you, so these amounts get no separate allocation. They are embedded in the total payments and expensed as incurred.1FASB. Accounting Standards Update 2016-02, Leases (Topic 842)
This split is where most of the confusion lives. People talk about property taxes and CAM as if they were the same thing, but the standard treats them differently.
Separating the Costs From the Lease Payment
When a lease bundles everything into one monthly number, you have to break the payment apart. For nonlease components like maintenance, ASC 842 requires allocating the total contract consideration between the lease component and any nonlease components based on their relative standalone prices. Where observable market prices exist, use them. Where they don’t, estimate using as much observable data as you can find.1FASB. Accounting Standards Update 2016-02, Leases (Topic 842)
Say your monthly payment is $10,000. Comparable CAM services in your market run about $1,200 per month, and similar property tax and insurance reimbursements total roughly $1,500. Only the remaining $7,300 attributable to the lease component (after the relative price allocation with the CAM nonlease component) feeds into the present value calculation for your lease liability and ROU asset. The $1,200 in CAM and $1,500 in taxes and insurance hit the income statement as operating expenses.
The allocation is easy when the landlord itemizes charges. It’s harder with a flat, all-inclusive payment. Third-party service quotes and local tax assessor records give you a defensible basis for the split.
The Practical Expedient
ASC 842 offers a shortcut. Under ASC 842-10-15-37, a lessee can make an accounting policy election, by class of underlying asset, to skip the separation and account for each lease component and its associated nonlease components as a single combined lease component.1FASB. Accounting Standards Update 2016-02, Leases (Topic 842)
Electing the expedient rolls CAM, maintenance fees, and other nonlease components into the lease component. The result is a larger ROU asset and a larger lease liability, because amounts that would otherwise have been expensed are now capitalized. For companies with heavy lease portfolios, the tradeoff between simplicity and balance sheet size is a real decision.
A few limits are worth noting. The election applies by class of underlying asset, not lease by lease. Elect it for office building leases and it applies to all of them. It only covers nonlease components. Property taxes and insurance are noncomponents, so this election doesn’t sweep them in the same way; they weren’t being allocated to begin with.
IFRS 16 offers a nearly identical option in paragraph 15, letting lessees elect by class of underlying asset not to separate non-lease components.2IFRS Foundation. IFRS 16 Leases
How Lease Structure Decides Who Pays
The lease type dictates whether these costs even appear on your books as separate line items.
In a gross lease, you pay one flat amount and the landlord covers taxes, insurance, and maintenance out of that payment. Your whole payment reads as a lease component because nothing was separately charged. Simpler accounting, higher base rent.
A triple net (NNN) lease is the opposite. Lower base rent, but you separately pay property taxes, insurance, and operating expenses. Some NNN leases also push roof and structural repairs, HVAC, and utilities onto the tenant. This is where the separation work matters most, because each cost category is visible and each needs correct treatment.
Modified gross leases split the difference. The landlord absorbs some costs and passes others through. Read the contract carefully to see which is which.
Income Statement and Tax Treatment
Whichever ASC 842 bucket they land in, executory costs share one income statement treatment: they hit operating expenses in the period the service is received or the obligation arises. Property taxes accrue ratably over the period they cover. Insurance premiums are expensed over the policy term. CAM charges post as billed or as services are consumed.
That’s a plain contrast with the lease component itself, where payments split between interest expense on the liability and amortization of the ROU asset. Executory costs skip that machinery and flow straight to the income statement.
For federal tax, these costs are deductible as ordinary and necessary business expenses under Internal Revenue Code Section 162, which allows deductions for expenses in carrying on a trade or business, including rental payments and costs tied to property the taxpayer uses but does not own.3Office of the Law Revision Counsel. 26 USC 162 – Trade or Business Expenses
Verifying What the Landlord Bills You
If you’re in a net lease and the landlord passes through taxes, insurance, and CAM, verify the numbers. Overcharges are more common than most tenants realize, which is why audit rights matter.
Well-drafted commercial leases include a clause letting the tenant examine the landlord’s books supporting the passthroughs. Windows to request an audit after the year-end reconciliation typically range from 60 days to one year. Examinations happen at the landlord’s office during business hours, and tenants are usually limited to one audit per expense period. Many leases restrict who can audit, sometimes barring contingency-fee auditors, and often require the tenant to be current on rent and free of default before exercising the right.
The most valuable clause is fee-shifting: if the audit reveals an overcharge above a threshold (commonly 3 to 5 percent), the landlord reimburses the audit costs on top of refunding the overcharge. Without it, auditor fees can swallow the recovery. If your lease doesn’t include audit rights, negotiating them in before signing is one of the highest-value moves a tenant’s attorney can make.
Why the Separation Matters
Getting this wrong is more than an accounting nuisance. Capitalizing taxes and maintenance into the ROU asset inflates both sides of the balance sheet and makes the company look more leveraged than it is. For businesses with debt covenants tied to total liabilities or leverage ratios, an overstated lease liability can trigger a technical default. Going the other way, electing the practical expedient when it doesn’t fit your situation buries operating costs inside the lease line and makes it harder for lenders and investors to read your cost structure.
The stakes climb with the size of the lease portfolio, especially for retailers, restaurant chains, and logistics companies with many locations. The principle holds at any scale: the balance sheet should reflect what you owe for the right to use an asset, and the income statement should reflect what you pay to keep it running.