Lease Incentives & fit out costs

Lease incentives

It is a lot more common for landlords of commercial properties to provide lease incentives to tenants, in particular in a ‘tenants’ market’ where the vacancy rate is on the rise.

The tax treatment of lease incentives can be quite complex, and landlords are well advised to fully understand their tax implications before offering such incentives to tenants.

If a landlord provides a tax-free period to a tenant, the foregone rent is neither assessable nor tax deductible to the landlord. On the other hand, the landlord may still claim other expenses incurred on the property (eg council rates) during the rent-free period. However, if the landlord provides a cash incentive to the tenant, the cash outlay will be tax deductible up front. The same applies if the landlord pays a cash amount to entice the tenant to vary the lease, relocate or stay on the premises.

If the landlord directly undertakes a fit-out of the property for a tenant or makes a fit-out contribution to the tenant, the tax treatment will depend on whether the landlord will retain ownership of the fit-out under the lease agreement.

If the landlord retains ownership of the fit-out, the costs incurred by the landlord will need to be analysed to determine the portion of the costs that are tax deductible up front, depreciable over the relevant depreciating assets’ effective life, and/or eligible for the capital works deduction.

On the other hand, if the tenant assumes ownership of the fit-out immediately, the costs incurred by the landlord will be tax deductible up front. . I have seen an alternative view that a CGT event (A1 or C2, depending on whether the lessor or lessee were deemed to be the owner) arises with an associated capital loss being the remaining un-deducted cost base of the improvements’. If the tenant is at the end of their lease and removes items and remains the owner of these assets, the tenant may need to complete a balancing adjustment based on the termination value of the capital asset.