Accounting for leasehold improvements

Q: How does it work with numbers?

Illustration only. A company signs a 10 year office lease with no break or extension options and spends £150,000 on fit out: £30,000 on air conditioning with an expected physical life of 15 years and £120,000 on partitions, flooring, lighting and joinery. The landlord pays the company £20,000 towards the works as an incentive. The office is ready on the first day of the lease. Improvements capitalised: £150,000 as property, plant and equipment. Annual depreciation: £150,000 over 10 years, the lease term being shorter than the 15 year physical life of the air conditioning, giving £15,000 a year with no residual value. Landlord's £20,000: deducted from the right of use asset, not from the improvements. If at the start of year 6 the company agrees an early surrender ending the lease after year 7, the remaining life of the improvements falls to 2 years. The carrying amount of £75,000 is depreciated over those 2 years at £37,500 a year as a change in estimate, and the position is checked for impairment.

Fit out work a tenant pays for on leased premises, such as partitions, lighting, flooring, air conditioning and fixed joinery, is the tenant’s own property, plant and equipment under Section 17 of FRS 102. It is capitalised at cost and depreciated over the shorter of its useful life and the period the tenant can use it, which in practice usually means the lease term. It is a separate asset from the right of use asset for the lease itself.

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What counts as a leasehold improvement?

A leasehold improvement is work the tenant carries out on premises it does not own, paid for by the tenant, which will benefit the business for more than one accounting period. Typical examples are office fit outs, shopfronts, kitchens in a restaurant, suspended ceilings, new electrical and data cabling, heating and cooling systems and internal partitions. Work that merely restores the premises to their previous condition is a repair, and is expensed; see capital versus revenue expenditure for that dividing line.

Because the tenant controls the use of the improvements for the lease period and expects economic benefits from them, they meet the recognition test for property, plant and equipment, even though they will usually pass to the landlord at the end of the lease. The basic rules are on the FRS 102 Section 17 page.

Which fit out costs can be capitalised?

Paragraph 17.10 of FRS 102 says cost includes the purchase price after trade discounts and any costs directly attributable to bringing the asset to the location and condition needed for it to operate as management intends, such as site preparation, delivery, installation and testing. It also includes the initial estimate of costs of dismantling and removing the item and restoring the site, where the entity has an obligation for those costs.

Paragraph 17.11 lists costs that are not part of an asset and must be expensed: costs of opening a new facility, costs of introducing a new product or service including advertising, costs of conducting business in a new location including staff training, and administration and general overheads. So contractor invoices, professional fees for designing and supervising the works and fixed equipment are capitalised, while relocation costs, launch events, temporary staff training at the new site and the business’s own management time generally are not.

Where a fit out includes items with clearly different lives, such as air conditioning plant and decorative finishes, paragraph 17.16 requires major components with significantly different patterns of consumption to be depreciated separately.

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Over what period are the improvements depreciated?

Paragraph 17.18 requires the depreciable amount to be allocated on a systematic basis over the asset’s useful life. Paragraph 17.21 lists the factors to consider, and factor (d) is legal or similar limits on the use of the asset, such as the expiry dates of related leases. Partitions that would physically last 20 years have a useful life to the tenant of only as long as it can occupy the building, because the tenant loses them when the lease ends.

The period to use is therefore normally the shorter of:

the physical or economic life of the improvement; and
the remaining lease term, including any extension the tenant is reasonably certain to take.

The revised Section 20, which applies for periods beginning on or after 1 January 2026, defines the lease term in paragraph 20.38 as the non cancellable period plus option periods the lessee is reasonably certain to exercise to extend, or not to exercise to terminate. Paragraph 20.41(b) lists significant leasehold improvements expected to have significant economic benefit when an option becomes exercisable as a factor pointing towards an extension being reasonably certain. A large fit out late in a lease can therefore lengthen the lease term itself. Paragraph 20.58 depreciates the right of use asset to the earlier of the end of its useful life and the end of the lease term, so it is sensible to align the depreciation period for the improvements with the same lease term judgement.

Depreciation starts when the improvements are available for use (paragraph 17.20), not when the invoices arrive. Under paragraph 17.19 the useful life is reviewed if circumstances change, for example if the tenant serves a break notice.

How do the improvements relate to the lease accounting?

From 2026 most tenants recognise a right of use asset and a lease liability. The improvements are not part of that asset; they are separate items of property, plant and equipment. Three points connect the two:

Landlord contributions: paragraph 20.47(b) deducts lease incentives received from the cost of the right of use asset. A cash contribution from the landlord towards the tenant’s fit out is commonly a lease incentive, so it reduces the right of use asset rather than the cost of the improvements.
Reinstatement: paragraph 20.47(d) adds to the right of use asset the estimated cost of restoring the underlying asset to the condition required by the lease. Where the obligation is to strip out the tenant’s own improvements, paragraph 17.10(c) puts the dismantling estimate into the cost of those improvements instead. See dilapidations provisions.
Short leases: where a tenant uses the recognition exemption for a short term lease, the rent is expensed, but improvements it pays for are still capitalised and depreciated over the short period it can use them. See lease exemptions.

How does it work with numbers?

Illustration only. A company signs a 10 year office lease with no break or extension options and spends £150,000 on fit out: £30,000 on air conditioning with an expected physical life of 15 years and £120,000 on partitions, flooring, lighting and joinery. The landlord pays the company £20,000 towards the works as an incentive. The office is ready on the first day of the lease.

Improvements capitalised: £150,000 as property, plant and equipment.
Annual depreciation: £150,000 over 10 years, the lease term being shorter than the 15 year physical life of the air conditioning, giving £15,000 a year with no residual value.
Landlord’s £20,000: deducted from the right of use asset, not from the improvements.

If at the start of year 6 the company agrees an early surrender ending the lease after year 7, the remaining life of the improvements falls to 2 years. The carrying amount of £75,000 is depreciated over those 2 years at £37,500 a year as a change in estimate, and the position is checked for impairment.

How are leasehold improvements treated for tax?

Depreciation is not deductible. Section 53 of the Corporation Tax Act 2009 prohibits a deduction for items of a capital nature in calculating trading profits, so relief comes through capital allowances instead, and different parts of a fit out qualify differently:

Plant and fixtures: items that function as plant, such as air conditioning units, qualify as plant and machinery.
Integral features: section 33A of the Capital Allowances Act 2001 treats electrical and lighting systems, cold water systems, space or water heating systems, powered ventilation and air cooling systems, lifts and escalators, and external solar shading as plant. Section 33A(6) excludes assets whose principal purpose is to insulate or enclose the interior of a building or to provide a permanent interior wall, floor or ceiling.
Builders’ work for plant: section 25 treats capital expenditure on alterations to an existing building incidental to the installation of plant as expenditure on that plant.
Structural fit out: walls, floors and ceilings that are not plant may qualify for the structures and buildings allowance, which HMRC guidance says can be claimed by a person who has paid costs towards the construction or renovation of a structure, at 3% a year from 1 April 2020 for Corporation Tax, if all construction contracts were entered into on or after 29 October 2018 and an allowance statement is held.

See capital allowances explained and the structures and buildings allowance.

What mistakes come up most often?

Depreciating improvements over their physical life when the lease is much shorter, leaving a balance to write off when the tenant leaves.
Netting a landlord contribution against the cost of the improvements instead of treating it as a lease incentive.
Capitalising relocation, training and opening costs that paragraph 17.11 requires to be expensed.
Recording the whole fit out as one asset with one rate, which loses the split needed for both component depreciation and the capital allowances claim.
Not writing off the remaining carrying amount when a lease ends early or the premises are vacated.

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Reviewed by Christine Anderson, Broker, Solar Protect. Last reviewed 8 October 2026. Part of Accountapedia, the Solar Protect guide to UK tax and accounting. This page is general information, not personalised advice.