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Tax Treatment of Leasehold Improvements

Tax Question:

What is the tax treatment of leasehold improvements related to real estate?

Facts:

In real estate, property and building leases are common-signed agreements between two corporations. Leasehold improvements are generally building additions for the lease space paid for by the tenant (lessee). These costs are considered capital and amortized over the length of the lease.

Discussion:

Common lease periods for real property are 5 to 10 years. The lease rates are negotiated by the lessor and the lessee at fair market value. The periodic lease payments are a deduction for the corporation. Upon termination of the lease, the leasehold improvements usually revert back to the lessor unless the lessee can remove them.

Leasehold improvements are categorized as Class 13 on the tax return. They are subject to the half-year rule for capital cost allowance (CCA) and they are amortized straight-line over the length of the lease (not declining balance method like most CCA classes). If the landlord incurs the cost directly, then costs are capitalized to the building. For tax purposes, they are usually classified as Class 1 at a declining balance rate of 4%.

Tenant inducements are costs paid by building owners to tenants during the initial lease period. They are offered to tenants as incentives to sign a long term lease. For example, a tenant may lease an unfinished office space and it may take 3 months for the office to be completely finished. The lessor may offer the tenant an inducement to cover the costs of the leasehold improvements. Inducements paid by the landlord to the tenant are required to be included as income to the tenant. Alternatively, the tenant may make an election to reduce the capital cost of the leasehold improvements. Rent-free periods may be offered as an incentive instead of inducements from the landlord to the tenant.


If you would like more information on types of ownership structures in real estate, please contact a member of the EPR Maple Ridge Langley team by filling out the contact form below.

Canadian and foreign tax laws are complex and have a tendency to change on a frequent basis. As such, the content published above is believed to be accurate as of the date of this post. Before implementing any tax planning, please seek professional advice from a qualified tax professional. EPR Maple Ridge Langley, Chartered Professional Accountants will not accept any liability for any tax ramifications that may result from acting based on the information contained above.


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