Can You Use Section 179 for Leasehold Improvements?
Learn the tax rules for expensing improvements to your leased commercial space. This guide covers eligibility and helps you navigate your deduction options.
When a business leases a commercial space, it often invests in modifications known as leasehold improvements, which can range from cosmetic updates to structural alterations. Section 179 of the Internal Revenue Code allows businesses to immediately expense the cost of certain property rather than depreciating it over many years. This can provide an immediate tax benefit, improving cash flow for the business.
Defining Qualified Improvement Property
Not all improvements a tenant makes are eligible for the same tax treatment. For an improvement to qualify for accelerated deductions, it must meet the specific definition of Qualified Improvement Property (QIP).
To be considered QIP, an improvement must be made to the interior portion of a non-residential real property, such as an office, retail store, or warehouse. The improvement must also be placed in service after the date the building was originally placed in service by any owner. This ensures the deduction applies to enhancements of existing commercial buildings.
Certain types of improvements are explicitly excluded from the QIP definition. Expenditures attributable to the enlargement of the building, any elevator or escalator, or the internal structural framework of the building do not qualify. For example, installing new interior drywall, ceilings, lighting systems, or flooring would generally be considered QIP, while adding a new wing or replacing main support beams would not.
Applying the Section 179 Deduction
Once a business confirms its leasehold improvement meets the definition of Qualified Improvement Property, it can apply the Section 179 deduction. This allows businesses to elect to fully expense these costs in the year they are incurred.
The Section 179 deduction is subject to specific dollar limitations that are adjusted annually for inflation. For the 2025 tax year, the maximum amount a business can expense is $1.29 million. This limit applies to the total Section 179 deduction a business can claim across all qualifying assets.
A phase-out threshold also applies, which limits the deduction for larger businesses. The deduction is reduced on a dollar-for-dollar basis if the total cost of qualifying property placed in service during the year exceeds a certain amount. For 2025, this phase-out threshold is $3.22 million, meaning the deduction is eliminated if a business places more than $4.51 million of property in service.
Furthermore, the Section 179 deduction is constrained by a business income limitation. The total deduction claimed cannot exceed the net taxable income of the business for the year, meaning it cannot be used to create a net operating loss. Any amount disallowed due to this income limitation can be carried forward to future tax years.
Interaction with Bonus Depreciation
Businesses can also use bonus depreciation for accelerating deductions on QIP, which allows for the immediate expensing of qualifying property. For property placed in service in 2024, the bonus depreciation rate is 60% and is scheduled to phase down in subsequent years. Unlike Section 179, bonus depreciation is not subject to an annual dollar limit or a business income limitation.
A primary difference is the impact of the business income limit. Because bonus depreciation is not limited by taxable income, it can be used to generate a net operating loss (NOL). A business can then carry this NOL forward to offset income in future years, which is useful for businesses with fluctuating income.
The election methods also differ. The Section 179 deduction is an “opt-in” provision, meaning a taxpayer must affirmatively elect to take it for each asset. In contrast, bonus depreciation is automatic for all eligible property, and a taxpayer must file an election to “opt-out” if they do not want to claim it.
State tax conformity is an important factor when choosing between the two deductions. Many states do not follow federal rules for bonus depreciation, requiring businesses to add the deduction back to their state income. State conformity with Section 179 rules is more common, which can simplify multi-state tax compliance.
Making the Election on Form 4562
A business must formally make the Section 179 election on its federal income tax return using IRS Form 4562, Depreciation and Amortization. This form is not filed separately but is included as part of the business’s complete annual tax return.
To make the election, the taxpayer must complete Part I of Form 4562. In this section, the business will list a description of the Qualified Improvement Property being expensed. The form requires the taxpayer to enter the cost of the property and then the amount they elect to expense under Section 179. The total elected amount from all assets is then calculated and carried through the form to determine any limitations that may apply.