Leasehold improvement depreciation: the life, the formula, and why the lease term is not the answer
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Leasehold improvement depreciation is the process of recovering the cost of a buildout over a defined life, either for tax purposes under MACRS or for book purposes under GAAP. The life is determined by how the improvement is classified, not by the length of the lease, which is where most of the confusion, and most of the money, sits.
What is the depreciation life of leasehold improvements?
| Classification | GDS recovery period | Method | Convention |
|---|---|---|---|
| Qualified improvement property | 15 years | Straight line, required | Half-year, or mid-quarter if triggered |
| Nonresidential real property | 39 years | Straight line only | Mid-month |
| Residential rental property | 27.5 years | Straight line only | Mid-month |
| Other 15-year property (not QIP) | 15 years | 150% declining balance, then straight line | Half-year, or mid-quarter if triggered |
What counts as qualified improvement property?
Qualified improvement property is an interior improvement to an existing nonresidential building, generally excluding enlargements, elevators and escalators, and internal structural framework. The distinction is worth pricing out: a $900,000 buildout classified as QIP recovers $60,000 a year over 15 years; classified as nonresidential real property, it recovers $23,077 a year over 39. Same construction, same invoices, a difference of roughly $37,000 in annual deduction.
Why the lease term is not the depreciation life
For tax purposes, the lease term does not set the recovery period. A ten-year lease with a $900,000 QIP buildout still recovers over 15 years under MACRS. Book purposes differ: GAAP generally depreciates over the shorter of useful life or the remaining lease term, so the same buildout can sit on a 15-year tax schedule and a 10-year book schedule at once, creating a deferred tax difference.
Where bonus depreciation currently sits
Under the One Big Beautiful Bill Act, there is a permanent 100% additional first-year depreciation deduction for qualified property acquired after 19 January 2025, with elections available to claim 40% or 60% for certain longer-period property. Because QIP is 15-year property, it sits inside the class eligible for this deduction, while 39-year nonresidential real property does not, making the classification the difference between recovering the cost immediately and recovering it across four decades.
One buildout, three schedules
| Tax depreciation | Book depreciation | ROU asset under ASC 842 | |
|---|---|---|---|
| What it measures | Cost recovery allowed by the tax code | Cost allocation over economic benefit | The right to use the leased space |
| The asset | The leasehold improvement | The leasehold improvement | The lease, not the improvement |
| Life used | 15 years for QIP, 39 for nonresidential real property | Shorter of useful life or remaining lease term | The lease term |
The leasehold improvement is not part of the right-of-use asset. Keeping these reconciled is ordinary lease accounting work, and it goes wrong when the lease data and the fixed asset register are maintained by teams that never compare notes.
FAQ
Can you depreciate leasehold improvements over the lease term?
- For book purposes, generally yes, over the shorter of useful life or the remaining lease term. For tax purposes under MACRS, no. The recovery period comes from the property’s classification, 15 years for QIP or 39 for nonresidential real property, regardless of lease length.
What is the difference between depreciation and amortization of a right-of-use asset?
- Depreciation recovers the cost of an asset you own, such as a leasehold improvement. Amortization of a right-of-use asset allocates the cost of the right to use leased space over the lease term. A buildout in leased space produces both, on separate schedules.
Do leasehold improvements qualify for bonus depreciation?
- Improvements classified as qualified improvement property are 15-year property and fall within the class eligible for the additional first-year deduction, currently a permanent 100% for property acquired after 19 January 2025. Nonresidential real property at 39 years does not qualify.
What happens to leasehold improvements when a lease ends early?
- The remaining net book value generally has to be addressed at termination or abandonment, and the treatment differs between book and tax, which is why knowing what is still on the books at that location matters before a remodel or consolidation.
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