Tenant Improvement Allowance Explained
Tenant Improvement Allowance Summary
A tenant improvement allowance (often called a lease improvement allowance or TI allowance) is a financial contribution from a landlord to help pay for build-out costs when a tenant moves into a commercial space. These allowances are commonly used to customize vacant or shell spaces and are a key negotiation point in commercial leases.
Tenant improvement allowances affect not only construction budgets, but also lease accounting, capitalization, and tax treatment, making them relevant to both business operators and accounting teams.
You’ve found the right location for your business, but the space is an empty shell. Turning that box into a functional office, retail store, or restaurant requires capital, planning, and careful coordination with your landlord. In many commercial leases, a tenant improvement allowance helps bridge that gap.
This guide explains how tenant improvement allowances work, how they are calculated, what costs they typically cover, and the accounting and financial considerations tenants should understand before signing a lease.
What Is a Tenant Improvement Allowance?
A tenant improvement allowance is a sum of money provided by the landlord to reimburse the tenant for costs associated with improving or building out leased space. These improvements typically become a permanent part of the property.
Landlords use tenant improvement allowances to:
- Attract long-term tenants
- Reduce vacancy risk
- Increase the long-term value of their property
From the tenant’s perspective, a TI allowance reduces upfront cash requirements and allows the space to be customized for operational needs.
How Tenant Improvement Allowances Are Calculated
Tenant improvement allowances are most commonly calculated on a per-square-foot basis.
For example:
- An allowance of $40 per square foot
- A leased space of 1,500 square feet
- Total TI allowance: $60,000
The per-square-foot rate varies widely depending on:
- Market conditions
- Property class
- Condition of the space (second-generation vs shell)
- Lease term length
From a negotiation standpoint, the TI allowance is one of the most important economic components of a commercial lease.
What Costs Can a Tenant Improvement Allowance Cover?
A tenant improvement allowance is not an unrestricted construction budget. Most leases limit the allowance to permanent improvements, often referred to as hard costs.
Commonly Covered Costs
- Interior walls and framing
- Electrical wiring and lighting
- Plumbing and restrooms
- HVAC systems
- Flooring and ceilings
These improvements become part of the landlord’s property and typically remain when the lease ends.
Costs Often Excluded
- Furniture and fixtures
- Equipment and inventory
- Technology hardware
- Signage and branding elements
- Decorative or movable items
Soft Costs and Professional Fees
Soft costs such as architectural design, engineering, permits, and project management may or may not be covered. Whether these costs are reimbursable should be explicitly stated in the lease.
Tenant Improvement Allowance vs Turnkey Build-Outs
Some landlords offer a turnkey build-out instead of a tenant improvement allowance.
With a turnkey arrangement:
- The landlord manages construction
- The tenant receives a move-in-ready space
- Costs are embedded in the lease economics
A tenant improvement allowance provides more control but requires the tenant to manage contractors and upfront payments. A turnkey build-out reduces complexity but limits customization.
The right option depends on timeline, internal resources, and design requirements.
Ownership of Tenant Improvements
One of the most common surprises for tenants is ownership.
In most commercial leases:
- Permanent improvements paid for with a tenant improvement allowance become the landlord’s property
- Ownership transfers regardless of who managed or funded the work
This distinction matters for both lease negotiations and accounting treatment, particularly when improvements are capitalized.
What Happens If Build-Out Costs Exceed the Allowance?
If construction costs exceed the tenant improvement allowance, the tenant is responsible for the overage.
For example:
- TI allowance: $50,000
- Actual build-out cost: $65,000
- Tenant-funded overage: $15,000
Cost overruns should be planned for in advance, especially for specialized or highly customized spaces.
How Tenant Improvement Allowances Are Paid
Tenant improvement allowances are typically paid as reimbursements, not upfront funding.
The process usually involves:
- Tenant pays contractors
- Tenant submits paid invoices and lien waivers
- Landlord reimburses eligible costs
This structure creates a short-term cash flow requirement that tenants should account for in budgeting.
Accounting Treatment of Tenant Improvement Allowances
From an accounting perspective, tenant improvement allowances require careful evaluation.
Key considerations include:
- Whether improvements are owned by the tenant or landlord
- Whether tenant-funded improvements are capitalized
- How allowances interact with lease accounting standards
Tenant improvements may be recorded as leasehold improvements and amortized over the shorter of the lease term or useful life. The allowance itself may reduce the recorded asset or be treated as a lease incentive, depending on lease structure and accounting policy.
Accounting teams should review tenant improvement allowances closely when preparing lease schedules and financial statements.
Tax Considerations for Tenant Improvement Allowances
Tenant improvement allowances may also have tax implications, including:
- Depreciation treatment
- Eligibility for bonus depreciation
- Impact on taxable income
Because tax treatment can vary by jurisdiction and lease structure, tenants should consult their tax advisor before finalizing a lease.
Tenant Improvement Allowance Checklist: Questions to Ask Before Signing
Before committing to a lease, tenants should confirm:
- What is the allowance per square foot and total dollar amount?
- Which costs are eligible for reimbursement?
- Are soft costs included?
- What documentation is required for reimbursement?
- Who owns the improvements at lease end?
- What happens if the full allowance is not used?
Legal and accounting review is strongly recommended before execution.
Tenant Improvement Allowance FAQs
What is a tenant improvement allowance?
A tenant improvement allowance is a landlord-funded contribution used to reimburse a tenant for costs associated with building out leased commercial space.
Is a tenant improvement allowance the same as leasehold improvements?
No. The allowance is the funding mechanism. Leasehold improvements refer to the physical improvements made to the space.
Are tenant improvement allowances taxable?
Tax treatment varies. In some cases, allowances may be treated as income or reduce the depreciable basis of improvements.
Who owns tenant improvements at the end of the lease?
In most leases, permanent improvements become the landlord’s property when the lease ends.
Are tenant improvement allowances paid upfront?
Typically no. Most allowances are reimbursed after work is completed, and invoices are submitted.
Final Thoughts
Tenant improvement allowances are a core component of commercial lease economics. While they reduce upfront build-out costs, they also introduce accounting, tax, and cash flow considerations that extend well beyond construction.
Understanding how tenant improvement allowances work and how they affect financial reporting helps tenants negotiate better
Brooke Colglazier
Marketing Manager