The difference between qualified and non-qualified leasehold improvements is the difference between deducting the full cost in year one and spreading it across 39 years of straight-line depreciation. Interior, non-structural work on a nonresidential building placed in service after the building itself qualifies as Qualified Improvement Property (QIP) and is eligible for a 15-year recovery period plus 100% bonus depreciation. Building enlargements, elevators and escalators, internal structural framework, and exterior work do not qualify and default to the 39-year life. Getting the classification right, and documenting it, is the single most consequential tax decision in any commercial build-out.
What Makes an Improvement Qualified
Under IRC Section 168(e)(6), Qualified Improvement Property is any improvement to the interior of a nonresidential building, as long as the improvement is placed in service after the building itself was first placed in service.1Internal Revenue Service. TCJA Depreciation Provisions Student Guide That’s the whole affirmative test. Two older barriers no longer apply:
- No lease required. QIP does not have to be made “pursuant to a lease.” An owner-occupant renovating their own commercial building qualifies on the same terms as a tenant improving rented space.
- No three-year waiting period. The pre-2018 Qualified Leasehold Improvement Property (QLIP) rules required the building to have been in service more than three years. QIP only requires that the improvement follow the building’s original in-service date, even by a few months.
If you still see references to QLIP, Qualified Restaurant Property, or Qualified Retail Improvement Property, those three categories were eliminated by the Tax Cuts and Jobs Act and rolled into the single QIP classification for property placed in service after 2017. QIP is now the only relevant classification.
Common area work such as lobby renovations or shared restroom upgrades can qualify. The current definition doesn’t carve those out the way the old QLIP rules did.
What Makes an Improvement Non-Qualified
The QIP definition contains three explicit exclusions. Spending in any of these categories gets the 39-year nonresidential real property life no matter how clearly it improves the interior:
- Building enlargements. Any work that increases the building’s total square footage, such as adding a wing or extending a floor plate.
- Elevators and escalators. Installing or replacing vertical transportation systems is specifically excluded.
- Internal structural framework. Work on load-bearing walls, columns, beams, or the building’s structural skeleton doesn’t qualify.1Internal Revenue Service. TCJA Depreciation Provisions Student Guide
Exterior work is also outside QIP because the definition covers only the interior portion of the building. Roof replacements, exterior wall re-cladding, and parking lot work are not interior improvements. Some of these have a separate accelerated path through Section 179, covered below, but they are not QIP.
What You Can Deduct on Qualified Property
QIP gets a 15-year MACRS recovery period using the straight-line method.2Office of the Law Revision Counsel. 26 US Code 168 – Accelerated Cost Recovery System That alone beats the 39-year life applied to non-qualifying nonresidential real property. But the real payoff is bonus depreciation.
For property acquired and placed in service after January 19, 2025, 100% bonus depreciation is permanent under the One, Big, Beautiful Bill Act. There is no sunset and no further phase-down.3Internal Revenue Service. Treasury, IRS Issue Guidance on the Additional First Year Depreciation Deduction Amended as Part of the One, Big, Beautiful Bill IRS Notice 2026-11 provides interim guidance confirming the permanent 100% rate.4Internal Revenue Service. Notice 2026-11 – Interim Guidance on Additional First Year Depreciation Deduction
A tenant who spends $500,000 on qualifying interior build-out in 2026 can deduct the full $500,000 in the year the work is placed in service. Treat that same $500,000 as non-qualifying 39-year property, and the annual deduction is roughly $12,820. That gap repeats every year a business invests in commercial space.
If your QIP was placed in service between January 1, 2023 and January 19, 2025, the phase-down rates applied: 80% in 2023, 60% in 2024, and 40% for the first 19 days of 2025. Remaining basis after the bonus deduction recovers over the standard 15-year schedule. Returns from that window may be worth a second look.
Section 179: A Path for Some Non-Qualified Items
Bonus depreciation isn’t the only route to a first-year write-off. Section 179 allows immediate expensing of qualifying property, and its definition of “qualified real property” includes QIP plus several items that are not QIP.5Office of the Law Revision Counsel. 26 USC 179 – Election to Expense Certain Depreciable Business Assets That gives taxpayers a way to accelerate deductions on improvements that would otherwise sit on the 39-year schedule.
The following improvements to nonresidential real property qualify for Section 179 expensing as long as they’re placed in service after the building was first placed in service:
- Roofs, including full replacements that would otherwise be a 39-year structural component.
- Heating, ventilation, and air-conditioning systems, both new installations and replacements.
- Fire protection and alarm systems, including sprinklers and fire detection equipment.
- Security systems, including access control and surveillance.5Office of the Law Revision Counsel. 26 USC 179 – Election to Expense Certain Depreciable Business Assets
Section 179 has an annual dollar cap that adjusts for inflation and phases out dollar-for-dollar once total qualifying purchases exceed a set threshold. Unlike bonus depreciation, it can be applied on an asset-by-asset basis, giving more control over how much comes out in any given year. Businesses report these deductions on IRS Form 4562.6Internal Revenue Service. About Form 4562, Depreciation and Amortization (Including Information on Listed Property)
The practical upshot: when a project mixes QIP-eligible interior work with non-QIP items like a new HVAC system serving the whole building, both components can be accelerated using different provisions.
Separating Qualified and Non-Qualified Costs Within One Project
Most substantial build-outs contain both. A single construction contract might cover new office partitions, upgraded electrical, a replaced elevator, and structural reinforcement. Treating the entire project as one asset and defaulting everything to 39 years is the most common and most expensive mistake taxpayers make with leasehold improvements.
The fix is componentization: breaking the total project cost into individual assets classified by tax treatment. Interior, non-structural work that meets the QIP definition gets the 15-year life and bonus depreciation. Structural components like elevator replacements or enlargements get 39-year treatment. HVAC, roof, fire, and security work can go through Section 179 even when it isn’t QIP.
A cost segregation study, typically prepared by an engineering firm working with a tax professional, documents the breakdown. The study identifies each component of the project, assigns it a recovery period, and provides the engineering rationale for the classification. Without one, the IRS can challenge an aggressive allocation and recharacterize deductions. For any project north of a few hundred thousand dollars, the cost of the study usually pays for itself many times over.
The documentation requirements are real. Retain construction contracts that break out costs by trade, architectural drawings showing what’s structural versus cosmetic, and invoices that itemize materials and labor by scope. If you can’t prove an improvement is interior, non-structural, and placed in service after the building’s original in-service date, it defaults to 39-year property.
What Happens to the Deduction When the Lease Ends
Classification affects more than the annual deduction. It also shapes what happens at lease termination.
When a tenant paid for improvements and permanently vacates without retaining any rights to them, the tenant can generally claim an abandonment loss equal to the remaining undepreciated basis. A tenant who took 100% bonus depreciation on QIP already has a basis of zero, so there’s no loss to claim. A tenant depreciating non-qualifying improvements over 39 years may have decades of unrecovered cost to write off as an ordinary loss in the year of abandonment. The improvements have to be irrevocably given up, not transferred to a subtenant or relocated.
When a tenant’s improvements revert to the landlord at lease end, the landlord generally does not recognize taxable income from receiving them. IRC Section 109 excludes from gross income the value of buildings or other improvements made by a lessee on the lessor’s property, as long as the value isn’t a substitute for rent.7Office of the Law Revision Counsel. 26 USC 109 – Improvements by Lessee on Lessors Property The landlord takes a zero basis in those improvements and has nothing to depreciate going forward. If the landlord originally paid, depreciation continues over whatever recovery period was assigned. If the tenant is contractually required to remove improvements on the way out, the removal cost is an ordinary business expense. Lease terms control how the tax consequences fall, which is a reason to work them out before the build-out starts, not after.