When small businesses lease office or retail space, unusual bookkeeping measures are inevitable. Additions or changes to rented space create unfamiliar accounting situations. Untangling the tax treatment for these scenarios typically triggers a cascade of questions regarding improvements, depreciation, and repairs.
Improvements: The tenant, rather than the landlord, generally pays for customization of rented space. As a tenant, you cannot designate your cost for changes to rented property as an expense. Rather, the amount spent appears on the balance sheet in an asset account called “Leasehold Improvements.” These include structural modifications such as adding walls or plumbing. The costs are depreciated over time.
Depreciation: Each element of improvement should be separately identified along with its cost. Depreciation periods vary depending on whether the improvement is floor covering, part of the building structure, or an appliance attached to the building. In most cases, the depreciation recorded for company bookkeeping is the same as the standardized amount established under tax law. When you move prior to the end of a tax-allowable period, the not-yet-depreciated improvement costs are written off upon abandonment.
Repairs: Minor repairs and maintenance are exceptions to depreciation as leasehold improvements. You may expense the cost to fix a floor tile or paint a room. Routine maintenance that makes the building fit to occupy counts as an expense on the income statement of your business, but a landlord will often pay for these measures. In addition, when the landlord pays for some of the tenant finish-out, that part of the leasehold improvements cost isn’t counted as a depreciable cost for your business.