Topic No. 304: How to Allocate Capital Improvement Costs

In order to pass through to tenants the cost of a capital improvement, the landlord must allocate the cost using a method that takes into account the extent to which each unit benefited from the improvement. Methods which may be appropriate, depending on the circumstances, include allocation based on equal division among all units or based on the square footage of each unit. A reasonable portion of a common area capital improvement cost must also be allocated to areas exclusively occupied or controlled by the landlord, such as a management office.

Where an improvement does not benefit all units, only those units benefited may be charged the capital improvement passthrough. For example, the cost of a new roof would be allocated to all units in the building, but the cost of new carpeting in an individual unit would be allocated to that unit only. Costs attributable to units where the rent cannot be raised (because of a lease restriction, owner occupancy or other reason) may not be allocated to the other units.

A new tenant cannot be charged for a capital improvement completed before the tenancy began since the owner was free to set a new market rent at the time the unit was vacant. In addition, capital improvement costs cannot be passed through to units that are first rented during the construction period or rented within six months of the commencement of work, unless ownership has changed in that period and the change of ownership occurred after the new tenancy commenced.

September 2006

 

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