For CFOs and controllers managing commercial lease portfolios, tenant improvement accounting is one of those areas where the stakes are high and the rules are unforgiving. Build-outs represent significant capital expenditures, and how you account for them directly affects your financial statements, tax position, and the metrics lenders and investors watch most closely.
The challenge is that tenant improvement accounting sits at the intersection of lease accounting (ASC 842), fixed asset management, and tax planning. Missteps don't just create compliance headaches: they can distort NOI, skew debt service coverage ratios, and can cost real dollars in missed tax deductions.
These issues compound for companies with multi-location rollouts, staggered build-outs, or overlapping lease terms. What starts as a single misclassification becomes a portfolio-wide problem that surfaces at the worst possible time: during a refinancing, an audit, or sale preparation.
Before recording any tenant improvement transaction, you need to determine who is the "accounting owner," either the lessor or the lessee. This isn't always obvious, and getting it wrong distorts both parties' financials.
Determining this allocation of ownership comes down to several variables: Was the improvement required by the lease, or voluntary? Who controlled the work? Would the improvements benefit future tenants, or are they specific to this lessee's operations? ASC 842 doesn't provide explicit guidance, which means judgment is required.
This is a common focus area in audits, loan covenant reviews, and transaction due diligence. Ownership errors typically surface during refinancing or sale preparation, when outside parties scrutinize your accounting for the first time. By then, unwinding the mistakes is painful and time-consuming. Document your analysis upfront: it's far cheaper than reconstructing it under pressure.
From the lessor's perspective, tenant improvement allowance accounting comes down to a single question: who owns the improvements after they're built?
If the lessor owns the improvements: The full cost gets capitalized as a fixed asset on your balance sheet and depreciated over the shorter of the improvement's useful life or the remaining lease term. The TIA has no impact on lease revenue: it's purely a balance sheet transaction. Your income statement shows normal lease revenue, while depreciation expense flows through separately.
If the lessee owns the improvements: The allowance must be amortized as a direct reduction of lease revenue over the lease term. This treatment materially impacts how the lease performs on your income statement.
The complexity arises because ownership isn't always obvious from lease language. Improvements that remain with the property, revert to the landlord at lease end, or are integral to the building's systems might be considered lessor-owned even if the tenant directed the construction. Conversely, specialized tenant equipment or removable improvements might be tenant-owned even if you wrote the check.
This is why explicit ownership language in the lease agreement matters. Ambiguous terms create accounting headaches, potential disputes during audits, and surprises when preparing financial statements. Finance teams should review TIA terms during lease negotiations—not after execution—to ensure the intended accounting treatment is actually supported by the lease language.
Tenant improvements are depreciated over the shorter of their useful life or the remaining lease term. That sounds simple, but the judgment calls create risk.
Using the wrong period quietly misstates earnings and often surfaces during lender review or diligence. Failing to reassess when lease terms change compounds the error. And when a lease terminates early, the remaining book value needs to be written off immediately. Companies that don't have clean processes here find themselves explaining surprises to auditors and investors.
For leases between related parties under common control, ASU 2023-01 allows amortization over the useful life to the common control group, even if that exceeds the lease term. That's a meaningful change worth understanding if intercompany leases are part of your portfolio.
There are several areas where real estate funds tend to err when it comes to managing tenant improvement accounting in an appropriate manner:
Ownership misclassification. The ownership analysis is often undocumented, incomplete, or never revisited when lease terms change. As a result, tenant improvements may be recorded by the wrong party, leading to misstated financials on both sides of the lease.
Timing errors. Initial build-out costs are sometimes classified as tenant improvements even though they were placed in service at the same time as the building. By definition, tenant improvements must be made after the building is placed in service, and misclassifying these costs can distort depreciation and NOI. Additionally, depreciation must begin upon completion of the work, not when payments to vendors are made.
Amortization mistakes. Funds frequently default to useful life or lease term without evaluating which is appropriate under the facts. Early lease terminations add another layer of risk when remaining book value is not written off as required.
Strong tenant improvement accounting is less about technical perfection and more about repeatable discipline. The funds that get this right treat TI decisions as part of a broader operating system, not a series of one-off judgments. That discipline shows up consistently in three places:
Document ownership determinations at the project level. Each conclusion should be supported by a clear analysis tied to the lease terms in effect at the time. These records become especially critical during refinancing, audits, and exit preparation, when assumptions are scrutinized and institutional memory is no longer enough.
Bring finance into lease negotiations early. The structure and timing of tenant improvement allowances directly affect accounting treatment, depreciation, and reported performance. Involving finance upfront allows these terms to be shaped intentionally, rather than managed after the fact.
Connect TI tracking to transaction readiness. Funds that maintain clean, well-documented TI records move through refinancing and sale processes with far less friction. Those that do not are forced into time-pressured reconstruction efforts, often uncovering issues late in the process and leaving value on the table.
Disciplined tenant improvement accounting creates leverage when it is treated as an operating priority rather than a technical afterthought. Funds that get this right unlock tax savings that flow directly to cash flow, present cleaner and more credible financials to lenders and investors, and reduce the risk of audit surprises that undermine confidence. When refinancing or exit discussions begin, accurate records and defensible positions streamline due diligence and keep deal timelines on track.
At G-Squared Partners, we specialize in commercial real estate accounting that goes beyond compliance. Our team brings deep expertise in lease accounting, fixed asset management, and other key concepts that help finance leaders get tenant improvement accounting right.
Contact us today to schedule a discovery call and learn how specialized CRE accounting support can strengthen your financial reporting and maximize your investment returns.