What is the tax treatment of leasehold improvements related to real estate?
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.
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% (see FAQ 258 on CCA for Real Estate).
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.
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