What Is a Leasehold?
A leasehold refers to an asset being leased, typically property such as a building or space within one. The lessee contracts with the lessor for the right to use the property in exchange for a series of scheduled payments over the term of the lease. Renting space in an office building for business use or renting a building for a retail store are examples of commercial leasehold arrangements.
Key Takeaways
- A leasehold is a term referring to an asset or property that a lessee (tenant) contracts to rent from a lessor (property owner) for an agreed-upon period, in exchange for scheduled payments.
- Retail store owners often utilize leasehold agreements rather than constructing their own buildings.
- Commercial leasehold contracts can be complex and include agreements on payment structure, breach of contract clauses, and leasehold improvement clauses.
- The contract specifies which party is responsible for leasehold improvements, such as building partitions, adding lighting, or constructing shelves.
- Leasehold improvements are not deductible by the IRS, but they are subject to depreciation.
Understanding Leaseholds
A leasehold contract outlines the terms of the agreement between the lessee (tenant) and the lessor (property owner or landlord). The contracts for commercial properties, like space in an office building, are typically complex, specifying landlord responsibilities, tenant responsibilities, security deposits, breach of contract clauses, and leasehold improvement clauses. Larger tenants may negotiate more favorable terms in exchange for leasing more space for a longer duration. Leases for commercial properties generally range from one to ten years.
Types of Leaseholds
There are several types of leaseholds, including tenancy for years, periodic tenancy, tenancy at sufferance, and tenancy at will.
Tenancy for Years
A tenancy for years spells out all details, including the exact duration and payment expected. The contract could last days or years, but it always has a set start and end date.
Periodic Tenancy
In a periodic tenancy, the renter is contracted for an unspecified period, with no predetermined expiration date. The terms start for a specific period, but continue until either party gives notice to terminate. For example, a yearly lease might convert to a month-to-month lease once the initial term ends, needing only a month’s notice for termination.
Tenancy at Sufferance
Tenancy at sufferance occurs when the lease expires but the tenant remains without the owner’s consent, often leading to eviction. If the landlord accepts rent after the lease expires, it usually becomes a month-to-month lease.
Tenancy at Will
A tenancy at will can be terminated anytime by either the landlord or tenant. This arrangement typically does not require a formal contract and does not specify the rental duration or payment terms, being governed by state laws and federal anti-discrimination laws.
Leasehold Improvements
Upon finalizing a lease agreement, the tenant begins making leasehold improvements according to the contract. These could include work on walls, ceilings, floor space, lighting, additional plumbing, shelving, and cabinets, which are recorded as fixed assets on the company’s balance sheet.
Leasehold improvements might be paid for by the tenant, the landlord, or both, depending on the contract. Some landlords may fund these improvements to attract tenants, especially when demand is high. However, leasehold improvements typically remain the landlord’s property once the lease ends. These enhancements are usually confined to a building’s interior; exterior modifications are not considered leasehold improvements.
Example of a Leasehold
Leaseholds are common for brick-and-mortar retailers, such as Best Buy Co., Inc. The company leases most of its buildings, executing leasehold improvements to standardize interiors functionally and aesthetically. Their leases often include renewal options and escalation clauses, alongside contingent rents based on revenue percentages. Rent expense is recognized on a straight-line basis over the primary lease term, accruing deferred rent for differences between straight-line expense amounts and payable rent. For some retailers, leasehold improvements are a significant part of total property and equipment expenditures.
Leasehold Interest
A leasehold interest involves an individual or entity leasing land or property from an owner for a specified period. The lessee holds exclusive rights to possess and use the asset during this period. Types of leasehold interests include a tenancy for years, periodic tenancy, tenancy at sufferance, and tenancy at will.
Leasehold interest typically refers to ground leases, often lasting several years. For instance, an individual might lease a lot for 40 years and construct a building on it, which they can then rent out while paying the owner for the lot use. This differs from a freehold interest, where an individual or entity has complete ownership and can use the property as they see fit.
Leasehold FAQs
What Is a Leasehold Estate?
A leasehold estate allows a tenant to use an owner’s property for a set duration, defined by lease agreements outlining terms of use, payment, and landlord obligations.
How Do You Depreciate Leasehold Improvements?
Leasehold improvements are not deductible. However, as part of the building, they are subject to depreciation over a 15-year schedule, which must be re-evaluated annually based on their economic life.
Which Type of Leasehold Has a Definite Beginning and Ending Date?
A tenancy for years includes a clear beginning and ending date, as specified in the contract.
The Bottom Line
A leasehold is an asset being leased, often encompassing properties like units in buildings. In exchange for scheduled payments, renters contract with owners for property usage over the lease term. Commercial leaseholds cover rental spaces for businesses such as stores or offices, while residential leaseholds cover properties for personal use.
Related Terms: lessee, lessor, ground lease, fixed asset.
References
- Cornell Law School Legal Information Institute. “Landlord-Tenant Law”.
- Legal Information Institute. “Tenancy for Years”.
- Legal Information Institute. “Periodic Tenancy”.
- Legal Dictionary. “Tenancy at Sufferance”.
- Legal Information Institute. “Tenancy at Will”.
- MassLegalHelp.org. “Chapter 4: What Kind of Tenancy Do You Have?” Page 63.
- The Law Dictionary. “Leasehold Interest”.
- The Legal Dictionary. “Leasehold Estate”.
