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Tenant Improvement Allowances in a California Commercial Lease

By Matthew Martinez, Founder, CEO & Managing Broker, Diamond Real Estate Group. California DRE #01869679.

A tenant improvement (TI) allowance is money a landlord agrees to contribute toward building out a commercial space for a tenant, usually stated as a dollar amount per square foot or a fixed sum and paid against documented construction costs. It is a negotiated lease term, not a standard figure: what’s reasonable depends on the condition of the space, the length of the lease, the rent, the tenant’s credit and who carries the risk of cost overruns.

In California, the build-out often costs more than a tenant expects because a permitted alteration can trigger accessibility upgrades outside the suite, energy code requirements and fire or health review. This guide explains the common TI structures, how the money is paid, what the state codes add, how allowances are treated for tax purposes and the lease clauses that decide who pays for what. It applies to office, retail, medical, industrial and hospitality space alike, with notes on the North Bay where local review matters.

Common ways to structure tenant improvements

Structure	How it works	Who carries overruns	Watch for
TI allowance	Landlord pays up to a set amount, per square foot or lump sum; tenant manages or approves the work	Tenant, above the allowance	Which costs qualify, the deadline to use it, how and when it’s paid
Turnkey build-out	Landlord builds the space to agreed plans and delivers it ready to occupy	Landlord, within the agreed scope	How detailed the plans are, change orders, delivery date and remedies for delay
Rent abatement instead of TI	Landlord gives free or reduced rent; tenant pays for the work	Tenant	Upfront cash needs; abatement that is lost on default
Amortized or additional TI	Landlord funds more than the base allowance, and the tenant repays it through added rent over the term	Tenant, through rent	Interest rate, term, and repayment of the unamortized balance if the lease ends early
As-is, tenant-funded	Tenant pays for all work with landlord approval	Tenant	Approval rights, restoration duties at lease end

Many deals combine these. A landlord might deliver the base building systems in working order as “landlord’s work,” then give an allowance for the tenant’s interior finishes as “tenant’s work.” The work letter, an exhibit to the lease, is where that split is written down. Our overview of commercial lease types explains how gross, modified gross and net leases change who pays for building systems after move-in.

How a TI allowance is paid

An allowance is rarely a check at lease signing. It is usually reimbursement or progress payments against completed work, with conditions. A typical sequence:

Space plan and budget. The tenant’s architect or designer prepares plans, and a contractor prices them before the lease terms are final.
Landlord approval of the plans, the contractor and sometimes the subcontractors.
Permits from the city or county building department, plus planning, fire or health review where the use requires it.
Construction, often with a landlord construction-management or supervision fee charged against the allowance.
Disbursement against invoices, lien releases from the contractor and suppliers, and final inspection sign-off, sometimes with a holdback until the tenant opens.

Landlords who don’t want to be responsible for a tenant’s contractor sometimes post and record a notice of nonresponsibility. Under Civil Code section 8444, it must be posted and recorded within 10 days after the owner learns of the work to be effective. Whether it protects a landlord that required or funded the work is a question for counsel. Diamond may refer you to partners we work with, such as architects and contractors; you’re free to choose any provider.

What is a reasonable TI allowance?

There is no single right number, and published national averages tell you little about a specific building. The useful question is what the space needs and what the lease economics can support. The factors that move the number:

Condition of the space. A second-generation suite that already has restrooms, lighting and HVAC zoning needs less than a cold shell.
Lease term. A landlord can justify more money over a longer term, because there are more months of rent to recover it.
How reusable the work is. Open office, standard restrooms and code upgrades help the next tenant; a specialized kitchen or lab may not.
Tenant credit and guaranty. A stronger tenant reduces the landlord’s risk of losing the investment.
Market conditions for that property type and location, and how long the space has been vacant.

Compare offers on a net effective basis. As an illustration only, not market data: for a 2,000-square-foot suite, a $40 per square foot allowance is $80,000 of construction funding, while three months of free rent at $5,000 a month is $15,000 of value. If the build-out will cost $100,000, the first offer leaves the tenant $20,000 to fund and the second leaves $85,000. Get a contractor’s budget before you sign a letter of intent, so the allowance request is tied to real costs. Our guide to negotiating a commercial lease covers how TI fits with rent, term and options.

California code triggers that drive TI cost

Accessibility path of travel (CBC 11B-202.4)

When an existing building is altered, the California Building Code generally requires the path of travel to the altered area to be made accessible too. The elements are addressed in a priority order: an accessible entrance, an accessible route to the altered area, accessible restrooms, public telephones, drinking fountains, and then other elements such as parking, storage and alarms.

The cost rule turns on a valuation threshold the Division of the State Architect updates every January. For 2026 it is $209,208, up from $203,611 in 2025. If the adjusted construction cost is at or below the threshold, path-of-travel work is required to the greatest extent possible without exceeding 20% of that cost. Above the threshold, full compliance is required unless the enforcing agency finds an unreasonable hardship, and then the spending can’t be less than 20%. Path-of-travel work itself is excluded from the adjusted construction cost.

That 20% can land on the landlord or the tenant depending on the lease, so decide in writing who pays for code work outside the premises. See our guide to CASp inspections and ADA compliance for commercial property.

CASp disclosure in the lease

Civil Code section 1938 requires every commercial lease signed on or after January 1, 2017 to state whether the premises have been inspected by a Certified Access Specialist. If a CASp report exists, the tenant must get a copy before signing, and if it arrives less than 48 hours before signing the tenant can rescind within 72 hours. Repairs of violations in the report are presumed to be the landlord’s responsibility unless the parties agree otherwise. If there has been no inspection, the lease must include a statutory statement about the tenant’s right to request one and the need to agree on who pays.

Energy code

The California Energy Commission’s 2025 Building Energy Efficiency Standards (Title 24, Part 6) apply to buildings whose permit applications are filed on or after January 1, 2026. Lighting and HVAC changes in a TI project can bring in energy-code requirements, so have the designer confirm the scope with the 2025 Nonresidential Compliance Manual early.

Permits and local review

A change in use, such as retail to restaurant or office to medical, can add planning, fire and health department review on top of the building permit. Ask the city or county about review steps before you commit to a delivery date. For North Bay specifics, see our pages on Sonoma County commercial property, Napa County commercial property, tasting room space and medical office space.

Who owns the improvements

The lease decides, and it should say so plainly. Improvements built into the space usually stay with the building at the end of the term, while the tenant’s trade fixtures, furniture and equipment remain the tenant’s. Read these provisions together:

Ownership and surrender: which improvements become the landlord’s property and the condition the space must be in at move-out.
Restoration or removal: whether the landlord can require the tenant to remove specialized work, such as a vault, a kitchen hood or interior stairs, and restore the space at the tenant’s cost.
Repayment on default: many leases require a tenant that defaults or leaves early to repay the unamortized part of the allowance and any amortized TI.

Industrial users should also pin down who owns power upgrades, racking and dock equipment; see our guide to industrial and warehouse space.

Tax treatment basics

Tax results depend on who owns the improvements and how the payment is structured, so bring a CPA into the lease negotiation, not after it. Three federal rules come up most often:

Section 110 retail allowances. A tenant can exclude a construction allowance from income when it is paid under a lease of retail space of 15 years or less, used to build or improve property that reverts to the landlord at the end of the lease, and only up to the amount the tenant actually spends. The landlord then treats the improvements as its own nonresidential real property. “Retail space” means space used to sell goods or services to the general public.
Qualified improvement property. An improvement made by the taxpayer to the interior of a nonresidential building after the building was first placed in service is generally 15-year property under Internal Revenue Code section 168. Enlargements, elevators and escalators, and the internal structural framework don’t qualify.
Expensing rules. IRS Publication 946 for 2025 notes that P.L. 119-21 reinstated a 100% special depreciation allowance for certain qualified property acquired and placed in service after January 19, 2025, and that qualified improvement property can be treated as section 179 property by election. Whether a particular build-out qualifies, and for whom, is a CPA question.

Lease clauses to read closely

The definition of the allowance and which costs it covers: construction only, or also design, permits, cabling, signage and furniture.
The deadline to use the allowance and what happens to unused funds; some leases let a tenant apply part of it to rent, and others say it is forfeited.
Disbursement conditions, retention and the landlord’s supervision fee.
The split between landlord’s work and tenant’s work, including who pays for path-of-travel and other code upgrades outside the suite.
The rent commencement date and how permit or construction delays affect it.
Repayment of unamortized TI on default, early termination or a buyout option.
Restoration and removal duties at the end of the term.
The CASp disclosure required by Civil Code section 1938.

Owners buying leased buildings should read the same clauses from the other side, since unpaid allowances and open construction obligations pass to a buyer; our commercial due diligence checklist and our guide to buying NNN leased property cover what to request. If you’re deciding whether to lease or buy, see owner-user commercial property.

Questions people ask

What is a reasonable tenant improvement allowance?

It depends on the space’s condition, the lease term, the rent, the tenant’s credit and how reusable the work is. Price the build-out with a contractor first, then negotiate an allowance tied to that budget rather than to a published average.

Do you have to pay back a tenant improvement allowance?

Not usually, if you complete the lease. Many leases require repayment of the unamortized balance if the tenant defaults or leaves early, and amortized TI is repaid through rent by design.

Is a TI allowance taxable income to the tenant?

Sometimes. Under Internal Revenue Code section 110, an allowance for a retail lease of 15 years or less that is spent on improvements that revert to the landlord can be excluded. Outside that rule, the answer depends on ownership and structure, so ask a CPA.

What is the difference between a TI allowance and a turnkey build-out?

With an allowance, the landlord pays up to a set amount and the tenant pays any overrun. With a turnkey deal, the landlord builds the space to agreed plans and takes the cost risk within that scope.

Who owns tenant improvements at the end of the lease?

The lease controls. Built-in improvements usually stay with the building, and trade fixtures and equipment stay with the tenant, but a landlord may require removal of specialized work.

Does a tenant improvement trigger ADA upgrades in California?

Usually, yes. An alteration generally requires path-of-travel upgrades, limited to 20% of the adjusted construction cost when that cost is at or below the 2026 threshold of $209,208.

Can an unused TI allowance be applied to rent?

Only if the lease says so. Many leases set a deadline after which unused funds are forfeited, so negotiate a rent credit or extension in advance if you expect to come in under budget.

If you’re negotiating a lease or comparing spaces and want the TI budget, the code triggers and the lease language reviewed together, our commercial real estate team can help; contact Diamond to start with the space you have in mind.

This is general information, not legal or tax advice; talk to a California commercial real estate attorney or tax adviser about your situation.

Sources & notes

Last reviewed October 2026 by Matthew Martinez.