Tenant Improvement Allowance Accounting: How Landlords and Tenants Handle TI Money the Right Way

Quick answer: A tenant improvement (TI) allowance is money a landlord gives a tenant to build out leased space. Under ASC 842, the tenant treats it as a lease incentive that reduces the right-of-use (ROU) asset, while the improvements themselves are capitalized as leasehold improvements. On the tax side, IRC Section 110 lets qualifying retail tenants exclude the allowance from income — but only under strict rules. Who owns the improvement and whether Section 110 applies decide who owes tax and who takes depreciation.

What a tenant improvement allowance actually is

A TI allowance (also called a TIA or build-out allowance) is a negotiated sum — often quoted per square foot — that a landlord contributes toward customizing a space: walls, flooring, lighting, HVAC modifications, and the like. For the landlord it’s a leasing incentive that helps close a deal and command higher rent. For the tenant it’s capital to make the space usable. Simple in concept, but the accounting and tax treatment are where property managers, landlords, and tenants routinely go wrong — and the mistakes are expensive.

How to account for a TI allowance under ASC 842

Under the current lease standard, ASC 842, a tenant improvement allowance is treated as a lease incentive. The core rule: the incentive reduces the ROU asset the tenant records at lease commencement. How it flows depends on timing.

• Allowance received at or before commencement: it directly reduces the ROU asset. The tenant separately capitalizes the build-out it paid for as a leasehold improvement asset and depreciates it.
• Allowance paid in the future (reimbursed later): the expected receivable reduces the lease payments used to measure the lease liability and ROU asset. In practice, future incentives are subtracted from the scheduled payments, and the net present value drives the opening lease liability and ROU asset.

The most common landmine is a variable or uncommitted allowance — one the tenant isn’t reasonably certain to receive. Those aren’t included in the initial measurement and are handled when the contingency resolves. If your lease says the allowance is contingent on landlord approval of plans, don’t bake it into day-one numbers as if it were guaranteed.

Who owns the improvement — and why it changes everything

The single question that reshapes both the books and the tax return: does the landlord or the tenant own the improvements?

If the improvements are lessee-owned, the tenant capitalizes and depreciates the leasehold improvements over the shorter of the useful life or the lease term, and the allowance is a lease incentive as described above. If the improvements are lessor-owned — the landlord funds and owns them — the landlord records the asset and depreciates it, and the tenant generally has no leasehold improvement asset for that portion. Lease language on ownership, removal obligations, and what happens at lease-end determines which path you’re on. Read it before you book anything.

The tax trap: Section 110 and taxable income

Here’s where money is won or lost. As a default tax rule, a tenant improvement allowance a tenant receives is taxable income — unless it fits a specific safe harbor. That safe harbor is IRC Section 110, the “qualified lessee construction allowance.”

Under Section 110, a tenant can exclude the allowance from gross income when all of these are true:

• The lease is for retail space.
• The lease is short-term — a term of 15 years or less.
• The allowance is expressly provided in the lease (or an ancillary agreement) for constructing or improving qualified long-term real property for the tenant’s business at that retail space.
• The exclusion is limited to amounts actually spent on the qualified improvements — any excess allowance over what the tenant spends is taxable.

When Section 110 applies, there’s a tradeoff: the improvements are treated as nonresidential real property of the lessor, so the landlord depreciates them (generally over 39 years) and the tenant doesn’t. When Section 110 doesn’t apply — for example, an office lease, a 20-year term, or an allowance that isn’t documented in the lease — the tenant typically must include the allowance in income and then depreciate the improvements it owns. Getting this analysis right, in advance, is the difference between a clean deal and a surprise tax bill.

Worked example

A retailer signs a 10-year lease for store space and negotiates a $200,000 TI allowance, expressly stated in the lease. The tenant spends the full $200,000 on qualified build-out.

• Books (ASC 842): the $200,000 incentive reduces the tenant’s ROU asset; the $200,000 build-out is capitalized as a leasehold improvement and depreciated over the shorter of useful life or the 10-year term.
• Tax (Section 110): because it’s retail, ≤15 years, documented, and fully spent, the tenant excludes the $200,000 from income. The improvements are treated as the landlord’s nonresidential real property, and the landlord depreciates them.

Change one fact — say the lease runs 18 years, or it’s an office instead of retail — and the tenant likely has $200,000 of taxable income to plan for.

Common tenant improvement allowance mistakes

• Recording the allowance as income or a payable instead of an ROU-asset reduction under ASC 842.
• Baking a contingent allowance into day-one measurement when receipt isn’t reasonably certain.
• Assuming the allowance is always tax-free — it’s taxable unless Section 110 (or another provision) applies.
• Missing the Section 110 documentation requirement — the allowance must be expressly provided in the lease.
• Both parties depreciating the same improvement because no one confirmed ownership.
• Ignoring excess allowance — anything above actual spend is taxable to the tenant.

Frequently asked questions

How is a tenant improvement allowance accounted for under ASC 842?

It’s treated as a lease incentive that reduces the tenant’s right-of-use asset. If paid at commencement it reduces the ROU asset directly; if paid later it reduces the lease payments used to measure the lease liability and ROU asset. The build-out is separately capitalized as a leasehold improvement.

Is a tenant improvement allowance taxable?

By default, yes — a TI allowance is taxable income to the tenant unless it qualifies for the IRC Section 110 exclusion or another applicable provision. Any allowance exceeding what the tenant actually spends on qualified improvements is taxable.

What is the Section 110 exclusion?

Section 110 lets a tenant exclude a construction allowance from income when the lease is for retail space, has a term of 15 years or less, expressly provides for the allowance, and the funds are spent on qualified long-term real property. The improvements are then treated as the lessor’s nonresidential real property.

Who depreciates tenant improvements — the landlord or the tenant?

It depends on ownership. If the tenant owns the improvements, the tenant depreciates them over the shorter of useful life or lease term. If the landlord owns them — or Section 110 applies — the landlord depreciates them, generally over 39 years.

Do you have to pay back a tenant improvement allowance?

Generally no — a TI allowance is a landlord contribution, not a loan, though some leases amortize it into rent or require repayment on early termination. Always check the lease’s specific terms.

Don’t let a build-out allowance turn into a tax surprise. Precision Accounting & Consulting helps New York landlords, property managers, and commercial tenants account for TI allowances correctly under ASC 842 and structure them for the best tax outcome under Section 110. See our accounting services or contact our team to review a lease before you sign. For more on commercial real estate reporting, read our guide to CAM reconciliation.

Related: For the full entry-by-entry mechanics, see tenant improvement allowance journal entries under ASC 842, including a complete worked example and the book-tax difference.

The entries behind the allowance. Deciding how a tenant improvement allowance is characterized is the analysis; recording it is a separate exercise with its own mechanics under ASC 842. We walk through the journal entries for a tenant improvement allowance step by step in a companion article.

For Manhattan tenants, how the allowance is structured can also affect the base rent used for the New York City commercial rent tax. Our guide to the NYC commercial rent tax explains which tenants are subject to it and how rent is measured.

Landlords handling allowances usually face the same year-end squeeze on operating expense recoveries, which is where CAM reconciliation support tends to pay for itself.