Leasehold Improvements vs Tenant Improvements: Complete Guide

In commercial real estate, understanding the difference between leasehold improvements and tenant improvements is crucial—for tenants, landlords, and property managers alike. While these terms are often used interchangeably, they have distinct meanings, especially in accounting, tax treatment, and lease negotiations.

This comprehensive guide defines each term, outlines when to use them, highlights real-world examples, and explores both Canadian and U.S. contexts. We’ll also break down who typically pays, how improvements are depreciated, and what motivates landlords to invest in these upgrades.

What Are Leasehold Improvements?

Leasehold improvements (LHI) are permanent changes made to a leased property to meet a tenant’s operational needs. These changes are physically attached to the building and usually remain after the lease ends.

Key Characteristics:

• Fixed or permanent in nature

• Typically paid for or initiated by the tenant, sometimes with landlord support

• Depreciated over the lease term (in Canada, via Capital Cost Allowance)

• Remain part of the property after lease expiration unless otherwise negotiated

Examples of Leasehold Improvements:

• Construction of walls, partitions, and doors

• Built-in cabinetry, millwork, or kitchenettes

• Plumbing and electrical rewiring

• Installing HVAC or modifying ductwork

• Custom reception desks or front counters

• Flooring replacements (e.g., hardwood, carpet tiles)

• Soundproofing for offices or meeting rooms

• Upgraded lighting and ceiling grids

• Washroom renovations

What Are Tenant Improvements?

Tenant improvements (TI) encompass all modifications made to a commercial space to make it functional for a specific tenant. This includes leasehold improvements but also extends to non-permanent changes and cosmetic upgrades.

Key Characteristics:

• Includes both permanent and temporary modifications

• Often funded through a tenant improvement allowance (TI allowance)

• Can include furniture, fixtures, and equipment (FF&E)

• Described in greater detail during lease negotiations and construction planning

Broader Examples of Tenant Improvements:

• Layout reconfiguration (creating private offices or open-concept work areas)

• Installing modular workstations or cubicles

• Security systems and access control

• AV infrastructure and smart technology integration

• Surveillance cameras and alarm systems

• Wi-Fi and structured cabling

• Painting and cosmetic décor

• Signage, branding elements, and wayfinding

• Temporary storage partitions or movable dividers

• Floor-to-ceiling window films for privacy or branding

Comparing Permanent vs Temporary Improvements

Here’s a clear comparison of the different dimensions between leasehold and tenant improvements:

Landlord’s Strategic Perspective: Why They Invest

Tenant improvements aren’t just a tenant concern. Landlords often use leasehold improvements strategically to attract and retain high-quality tenants—especially in competitive office or retail markets.

Landlord Motivations:

• Increase property value: Modern fit-outs improve lease rates and marketability

• Reduce vacancy periods: Pre-built or turnkey spaces appeal to fast-moving tenants

• Secure long-term tenants: Custom builds may encourage longer lease terms

• Tailor spaces by tenant type: Healthcare, tech, or legal tenants all have different infrastructure needs

Return on Investment (ROI) for Landlords:

• A well-designed improvement package can justify premium rents

• Build-outs aligned with market demand can decrease downtime between leases

• Improvements may qualify as capital expenses, improving tax positioning

Example: A landlord installs modern lighting, security systems, and open-floor layouts as part of a TI allowance. As a result, the space attracts a well-known design firm for a 10-year lease—reducing risk and increasing long-term rental income.

Who Pays for Improvements?

Tenant improvements can be funded in various ways depending on lease negotiations:

1. Tenant-Funded Improvements

The tenant pays directly or finances the build-out independently. This often happens when improvements are highly customized or exceed the landlord’s standard contribution.

2. Landlord-Funded (TI Allowance)

The landlord offers a fixed amount—often per square foot—for the tenant to use toward improvements. Any costs beyond this amount are typically covered by the tenant.

3. Shared Cost

Landlords may fund the base build (e.g., lighting, HVAC), while tenants pay for finishes, branding, and furniture.

Tip: Negotiate TI allowances during the lease negotiation phase, not after signing.

Canadian Tax Treatment of Leasehold Improvements

In Canada, leasehold improvements are classified under Class 13 for Capital Cost Allowance (CCA) purposes.

Depreciation Rules:

• Amortized over the term of the lease (including the first renewal term), or 40 years—whichever is shorter

• Subject to the half-year rule in the first year

• If the lease is terminated early, the tenant may claim a terminal loss on the remaining undepreciated amount

Landlords may treat TI allowances as:

• Capital expenses (if improvements increase the property’s long-term value)

• Lease inducements (which can be amortized over the lease term)

Always consult a tax professional to ensure proper classification and compliance with CRA rules.

U.S. vs Canadian Context: Key Differences

Although Canada and the U.S. share similarities in terminology, there are some notable differences in how improvements are treated:

Note: U.S. tenants can often deduct QIP more aggressively thanks to Section 179 and bonus depreciation rules. Canadian tenants follow more structured CCA limits.

When to Use Each Term

Understanding the correct usage of “leasehold improvements” vs. “tenant improvements” depends on context:

Real-World Examples by Industry

Retail Store

• Leasehold: Partition walls, flooring, built-in displays

• Tenant: POS kiosks, branding signage, security cameras

Tech Startup

• Leasehold: Cabling, breakout rooms, lighting upgrades

• Tenant: Modular desks, ergonomic chairs, whiteboards

Dental Clinic

• Leasehold: Plumbing for chairs, sterilization area walls

• Tenant: Dental chairs, X-ray equipment, privacy screens

Law Firm

• Leasehold: Soundproof boardrooms, private offices

• Tenant: Custom desks, security system, library shelving

Frequently Asked Questions

Is there a difference between leasehold and tenant improvements?

Yes. Leasehold improvements are permanent fixtures capitalized and depreciated over time. Tenant improvements include both permanent and temporary modifications tailored to a tenant’s use.

Can tenant improvements be removed at the end of the lease?

Yes—if they’re temporary or classified as trade fixtures. Leasehold improvements generally remain unless otherwise specified in the lease.

Who owns leasehold improvements?

Typically, ownership reverts to the landlord once installed. However, lease terms may define different arrangements.

How can tenants benefit from a TI allowance?

It offsets upfront costs, making it easier to occupy and customize space. It also reduces capital expenditure in the early months of operation.

What’s the risk of not documenting improvements properly?

Improper classification can result in lost tax deductions, inaccurate asset tracking, and future disputes about ownership or removal.

Final Thoughts: Get the Most From Your Commercial Space

Whether you’re a tenant customizing your first office or a landlord repositioning your property to attract premium clients, understanding the difference between leasehold improvements and tenant improvements is essential.

By clearly defining each, negotiating appropriate allowances, and working with professionals who understand commercial real estate law and tax strategy, you can optimize both functionality and financial return—on both sides of the lease.