Yes — a landlord can depreciate tenant improvements the landlord paid for and owns, and a cost segregation study decides how much of that build-out is recovered quickly on the 2026 return when the improvements are placed in service in 2026. Tax ownership for depreciation generally follows who bears the cost and holds the benefits and burdens, so landlord-funded improvements are usually depreciated by the landlord, while tenant-funded improvements are generally depreciated by the tenant.
For an office, retail or industrial landlord funding a 2026 build-out, cost segregation is most useful when the study separates the tenant work into qualified improvement property, shorter-life personal property and 39-year nonresidential real property under §168. A cost segregation study does not change who owns the asset, but it can change the timing of depreciation when the landlord owns the improvements and the property is ready and available for the tenant’s intended use.
Who depreciates tenant improvements when the landlord pays for the build-out?
The landlord generally depreciates tenant improvements when the landlord pays for the work, owns the improvements under the lease and bears the economic benefits and burdens of the build-out. In that fact pattern, the improvements are part of the landlord’s depreciable basis, and the tenant usually does not depreciate what it did not pay for and does not own.
The lease matters because it may say whether the improvements become the landlord’s property as installed, whether the tenant must remove them, and whether an allowance is paid to the tenant rather than to contractors. A qualified lessee construction allowance under §110 is the exception: when a landlord pays an allowance to a tenant under a short-term lease (15 years or less) of retail space, the lease expressly says the allowance is for constructing or improving qualified long-term real property for the tenant’s use at that space, and the tenant spends it for that purpose, §110 lets the tenant exclude the allowance from income and the landlord treats the amount as its own nonresidential real property, which is 39-year property that is not QIP and not bonus-eligible. An allowance that does not meet those §110 conditions is not covered by this exception.
If the tenant pays for specialized equipment, trade fixtures or leasehold improvements that the tenant owns and removes, the tenant generally depreciates those assets under §168 rather than the landlord, and under §168(i)(8)(A) a leasehold improvement is recovered over its MACRS recovery period regardless of the length of the lease term. If the landlord reimburses the tenant or funds an allowance, a tax advisor typically traces the lease language, invoices and payment flow before the landlord treats the full amount as its own depreciable basis.
This is where cost segregation starts: first confirm the landlord owns the improvements, then classify the landlord’s basis into the proper recovery periods. If ownership is unclear, a cost segregation report cannot fix a lease or reimbursement structure that points the tax ownership to the tenant.
Which tenant improvements can cost segregation move out of 39-year property?
Cost segregation can move qualifying parts of a landlord-owned tenant build-out out of 39-year nonresidential real property when the assets meet the shorter-life property rules under §168. The largest category for interior commercial build-outs is often qualified improvement property, or QIP.
Qualified improvement property means an improvement made by the taxpayer to the interior portion of nonresidential real property when the improvement is placed in service after the building was first placed in service, and §168(e)(6) excludes enlargements of the building, elevators, escalators and internal structural framework. Under §168(e)(3)(E)(vii), QIP is 15-year property, and under §168(k), QIP can be bonus-eligible (at 100% only if acquired after January 19, 2025) because bonus depreciation applies only to property with a recovery period of 20 years or less.
For a deeper discussion of the QIP rules, see Qualified Improvement Property: The 15-Year Asset Hiding in Your Build-Out. In a tenant build-out, QIP may include qualifying interior partitions, interior doors, certain interior finishes and other interior improvements when the §168(e)(6) conditions are met.
Cost segregation may also identify 5-year or 7-year property under §168 when the build-out includes assets that are not structural building components, such as certain dedicated equipment, specialty electrical serving equipment, removable millwork or process-related improvements. Exterior work, structural work, building enlargements, roofs and core building systems generally stay in 39-year nonresidential real property under §168 when they are structural components of the building.
Practical rule: cost segregation does not turn every tenant improvement into bonus-eligible property; it separates the build-out into QIP, shorter-life tangible personal property and 39-year building components based on the facts and the §168 categories.
ClickDrag Finance, built on the methodology in the IRS Cost Segregation Audit Techniques Guide
What does placed in service by December 31, 2026 mean for a calendar-year landlord?
For a calendar-year taxpayer, tenant improvements placed in service by December 31, 2026 can be depreciated on the 2026 return when the improvements are in a condition or state of readiness and availability for their specifically assigned function under Treas. Reg. §1.46-3(d)(1)(ii) and Treas. Reg. §1.167(a)-11(e)(1)(i). For a tenant build-out, that usually means the improved space is ready and available for the tenant’s intended office, retail or industrial use, not merely that invoices were paid.
A landlord’s acquisition date, lease signing date, permit date or construction completion date may be evidence, but the placed-in-service test asks whether the improvements are ready and available for the assigned function under Treas. Reg. §1.46-3(d)(1)(ii). If an office suite still lacks required occupancy approval, life-safety completion or tenant access needed for the intended use, your tax advisor may conclude that the improvements are not yet placed in service.
For a calendar-year taxpayer, tenant improvements placed in service (ready and available for their intended use) by December 31, 2026 go on the 2026 return, while tenant improvements first placed in service on January 1, 2027 or later are first depreciated on the 2027 return under the taxpayer’s depreciation method. A fiscal-year landlord uses the end of its own tax year instead of the calendar-year cutoff.
Placing a build-out in service for the deduction alone does not work as planning, because depreciation accelerates recovery of the same basis under §168 and does not create additional basis or cash. The business question is whether the space is truly ready for its tenant use, with the tax result following that fact.
How does 100% bonus depreciation apply to landlord-funded tenant improvements in 2026?
Under §168(k), 100% bonus depreciation applies to qualified property acquired after January 19, 2025 and placed in service in 2026 when the property otherwise meets the bonus rules. For a landlord-funded build-out, that can include QIP and certain 5-year or 7-year property identified by cost segregation, but it does not include land or the 39-year building shell.
IRS Notice 2026-11 ties the acquired date for a written binding contract to the latest of the date the contract was signed, the date the contract became enforceable under state law, the end of any cancellation period and the date any contingency was satisfied, using Treas. Reg. §1.168(k)-2(b)(5)(ii)(B). A written binding contract for this rule must be enforceable under state law and must not limit damages to a specified amount, such as through a liquidated-damages clause, under Treas. Reg. §1.168(k)-2(b)(5)(iii).
When the construction contract is not a written binding contract in that sense, the acquired date is generally when the taxpayer has paid or incurred more than 10 percent of the total cost, excluding land and preliminary activities, under Treas. Reg. §1.168(k)-2(b)(5)(iii) and Treas. Reg. §1.168(k)-2(b)(5)(v). For self-constructed property, including property built for the taxpayer under a written binding contract entered into before construction began, the property is acquired when physical work of a significant nature begins, and paying or incurring more than 10 percent of the total cost excluding land and preliminary activities is a safe harbor under Treas. Reg. §1.168(k)-2(b)(5)(iv) and the safe harbor in Treas. Reg. §1.168(k)-2(b)(5)(iv)(B)(2).
Qualified property acquired on or before January 19, 2025 and placed in service in 2026 stays on the TCJA phase-down at 20% bonus for 2026 under §168(k), except that long-production-period property and certain aircraft under §168(k)(2)(B) and §168(k)(2)(C) run a year behind. Used property qualifies for bonus only when the used-property rules in §168(k)(2)(E)(ii) are met, and a taxpayer may elect out of bonus for a class of property for a taxable year under §168(k)(7).
Cost segregation matters because the 100% or 20% bonus rate applies only after the build-out basis is sorted into bonus-eligible property. If the full build-out is left as 39-year nonresidential real property, the landlord may miss the faster deductions available for QIP and shorter-life assets.
Will the mid-quarter convention reduce the first-year depreciation on a late-2026 build-out?
The mid-quarter convention can reduce regular first-year depreciation on certain late-2026 tenant-improvement assets when §168(d)(3) applies, but bonus depreciation under §168(k) is not reduced by a depreciation convention. Nonresidential real property (39-year) and residential rental property (27.5-year) use the mid-month convention under §168(d), so a 39-year building component placed in service in any part of a month is treated as placed in service at the middle of that month.
Other MACRS property, including 5-year, 7-year and 15-year property identified by cost segregation, generally uses the half-year convention under §168(d) unless the mid-quarter convention applies. The mid-quarter convention applies under §168(d)(3)(A) when the aggregate basis of property placed in service during the last three months of the taxable year is more than 40% of the aggregate basis of all property placed in service during that year, with residential rental and nonresidential real property excluded from the test under §168(d)(3)(B), as is property placed in service and disposed of in the same year.
When §168(d)(3) applies, fourth-quarter property receives one and one-half months of regular first-year depreciation under the mid-quarter convention. Because bonus depreciation under §168(k) is not reduced by any convention, the convention issue matters mainly for property on which bonus is not claimed or is not available. Basis expensed under §179 is left out of the 40% test (Treas. Reg. §1.168(d)-1(b)(4)); have the tax advisor confirm how bonus-depreciated basis is counted and run the test on the full placed-in-service schedule.
What happens when the tenant leaves and the landlord removes the build-out?
When a landlord made leasehold improvements for a tenant and the tenant ceases to use them at the termination of the lease, §168(i)(8)(B) treats the landlord as having disposed of the improvements if the landlord disposes of or abandons them at that termination, and the landlord can then deduct their remaining adjusted basis. Removing only part of a build-out is a partial disposition under Treas. Reg. §1.168(i)-8, and the landlord can recognize a loss on the removed portion only by making the partial disposition election on a timely filed original return (including extensions) for the year of disposition. This is easier to support when cost segregation has already assigned a separate basis to the tenant-specific improvements; see When You Renovate, Stop Depreciating the Wall You Tore Out.
For example, if a retailer leaves and the landlord removes interior partitions, specialty lighting and dedicated finishes to prepare the space for a new tenant, the landlord needs records showing what was removed and what basis remains. A cost segregation study can support that allocation because it separates the build-out into components rather than leaving one undivided improvement account.
If the landlord simply reuses the improvements for a new tenant, §168(i)(8) does not apply because the improvements have not been disposed of or abandoned. If the landlord removes only part of a build-out, photos, demolition invoices and the original cost segregation detail help the tax advisor measure the disposed portion.
When is a cost segregation study worth it for a landlord-funded tenant build-out?
A cost segregation study is worth it when three conditions hold together: the basis is large enough for the accelerated deductions to outweigh the cost of the study, the deduction is usable this year given the owner's passive-activity position, and the hold is long enough to survive recapture. All three, or the honest answer is no.
For a rental real estate landlord, the deduction may be passive because a rental activity is passive under §469(c)(2) unless an exception such as §469(c)(7) applies. A passive loss that passive income does not absorb is disallowed under §469(a) and carried forward under §469(b).
Under §469(i), an individual who actively participates in a rental real estate activity (a separate test from material participation, and one that requires an interest of at least 10% by value (a spouse’s interest counts) throughout the year) is exempt from the §469(a) disallowance for up to $25,000 of loss from the rental real estate activities in which the individual actively participates; the $25,000 is reduced by 50% of modified adjusted gross income above $100,000 and is gone at $150,000, and for a married individual filing separately it is $12,500, phasing out between $50,000 and $75,000, only if the spouses lived apart for the entire year, and zero if they lived together at any time during the year.
Under §469(c)(7), a taxpayer is a real estate professional only if more than one-half of the personal services the taxpayer performs in trades or businesses during the year are performed in real property trades or businesses in which the taxpayer materially participates, and the taxpayer performs more than 750 hours of services during the year in real property trades or businesses in which the taxpayer materially participates (on a joint return, one spouse must meet both tests alone); the rental loss is then nonpassive only if the taxpayer also materially participates in that rental activity, with each rental tested separately unless the election under Treas. Reg. §1.469-9(g) to treat all interests in rental real estate as one activity was made. If a loss is nonpassive, it can offset wages or other nonpassive income only when the basis rules, at-risk rules under §465 and excess business loss limit under §461(l) also allow the deduction.
Recapture also belongs in the decision. On a taxable sale at a gain, recapture applies up to the amount of that gain however long the property was held, outside the Opportunity Zone rule that, for a qualifying investment held at least 10 years with the IRC §1400Z-2(c) election, applies on a sale of the qualified opportunity fund interest: §1245 recapture on 5-year and 7-year property is ordinary income, §1250 recapture of depreciation taken above straight-line, including bonus, on 15-year property such as QIP and land improvements held more than one year is ordinary income, and the rest of the depreciation on that 15-year property and on the 39-year structure is unrecaptured §1250 gain taxed at up to 25% for a noncorporate taxpayer. Cost segregation accelerates deductions; over the life of the building the same basis is recovered.
If you are also planning through an Opportunity Zone structure, compare the exit rules at Opportunity Zone Cost Segregation before treating recapture and bonus depreciation as ordinary commercial-building issues. A landlord that wants a first screen before the 2026 return planning is locked can start with ClickDrag’s cost segregation qualifier; the ownership, timing and §469 questions above stay with the tax advisor.
What documents should the landlord gather before requesting the study?
The landlord should gather the documents that show ownership, cost and use because cost segregation depends on the lease, the payment trail and the construction detail. Useful records include the lease and allowance provisions, the closing or settlement statement if the building was recently purchased, construction costs and invoices, contractor pay applications, the current depreciation schedule and a land-value source such as an assessor ratio or appraisal.
For tenant improvements, add plans, finish schedules, change orders, permit records, occupancy approvals, tenant acceptance records and photos of the completed work. If the landlord has multiple tenants or phases, label the costs by suite, tenant and placed-in-service date so the study can separate 2026 assets from later assets.
If the building was placed in service in an earlier tax year, ask your tax advisor whether the tenant improvements go on the original 2026 return, an amended return or a Form 3115 method change. Under section 6.01 of Rev. Proc. 2025-23, filed under the procedures of Rev. Proc. 2015-13, Form 3115 reports missed depreciation as a §481(a) adjustment with no amended returns when the property has been depreciated on two or more filed returns, or on one filed return if you placed the property in service in the tax year immediately before the year of change, you still owned it at the start of the year of change and the other eligibility rules are met.
For a 2026 calendar-year return, a tenant build-out placed in service in 2026 goes on the 2026 return and needs no Form 3115. For a building you placed in service in 2024 or earlier and still own, Form 3115 can be used with the 2026 return under section 6.01 of Rev. Proc. 2025-23 and Rev. Proc. 2015-13 when the eligibility rules are met; for a building you placed in service in 2025 with the 2025 return filed, Form 3115 with the 2026 return or an amended 2025 return filed before the 2026 return is filed are both available when the eligibility rules are met.
A prior election out of bonus depreciation cannot be undone through this accounting-method change under section 6.01(1)(c)(vi) of Rev. Proc. 2025-23. If you want to compare study providers and methodology questions, see Best Cost Segregation Companies, and confirm the filing route with your tax advisor.
Related reading: Bonus Depreciation in 2026: What Real Estate Owners Need to Know, The January 19, 2025 Line: How the Acquired-Date Test Sets Your Bonus Depreciation Rate and Bonus Depreciation in 2026: 100% Is Permanent for Post-Jan. 19, 2025 Property (and What Still Phases Down).
Frequently Asked Questions
Can a landlord depreciate tenant improvements it paid for?
Yes, a landlord can depreciate tenant improvements it paid for when the landlord owns the improvements and bears the benefits and burdens of ownership. The lease, allowance structure, invoices and payment records should show whether the landlord or tenant owns the depreciable property.
Does cost segregation make tenant improvements eligible for bonus depreciation?
Cost segregation can identify tenant-improvement components that are eligible for bonus depreciation when the assets are QIP or other property with a recovery period of 20 years or less under §168(k). The study does not make land, the 39-year building shell or excluded structural work bonus-eligible.
When do landlord-funded tenant improvements go on the 2026 depreciation schedule?
For a calendar-year taxpayer, landlord-funded tenant improvements placed in service by December 31, 2026 go on the 2026 depreciation schedule when they are ready and available for the tenant’s intended use under Treas. Reg. §1.46-3(d)(1)(ii). Improvements first placed in service on January 1, 2027 or later are first depreciated on the 2027 return.
Can a landlord write off tenant improvements when the tenant leaves?
Yes, under §168(i)(8)(B) a landlord that disposes of or abandons a leasehold improvement it made for the lessee when the lease terminates takes the improvement’s remaining adjusted basis into account in determining gain or loss, so depreciation the cost segregation study did not yet recover is not stranded on the schedule; improvements the landlord keeps in service for the next tenant are not disposed of and keep depreciating.
Is the depreciation on landlord-funded tenant improvements a passive loss?
Depreciation on landlord-funded tenant improvements is generally part of a rental activity, which is passive under §469(c)(2) unless an exception such as §469(c)(7) applies, and the loss can offset other income only when §469 does not disallow it and the basis rules, at-risk rules under §465 and excess business loss limit under §461(l) also allow the deduction. Rental losses are generally passive, so the passive-loss position is typically reviewed before relying on the accelerated deduction.