Accounting: How to budget for dilapidation repairs

The majority of commercial leases clearly set out the requirements for tenants to maintain a property in a good condition throughout the lease term and to return the property to its original state, such as by redecorating and removing branding and alterations, when the lease expires.

The precise details and costs of these dilapidations differ from lease to lease, but it is important for tenants to make financial provisions for these works throughout the lease to avoid a significant claim from the landlord when they leave the property. The cost of dilapidations can often run into five or six figures depending on the property and the alterations made, so spreading the cost of this work over the term of the lease can reduce the financial burden.

Companies that fail to adequately plan for the costs of dilapidations can find themselves ‘trapped’ into renewing a lease for a property that is no longer suitable for their business but where they cannot afford the cost of dilapidations that would trigger if they terminated the lease.

There are also tax benefits for dilapidations planning during the lease. Many dilapidations costs are tax-deductible as longas they are not considered to be capital expenditure by HMRC. And the annual provision that is made for these works can help reduce tax bills for every year of the lease instead of just the year in which the works are carried out. To determine how much to set aside for these works, it may be useful to discuss what will be required with a chartered surveyor and reliable dilapidation contractor for a more complete estimate.

What happens if the reinstatement works are over or under the estimate?

An estimate for the cost of dilapidation works are just that — an estimate. Inevitably there will be adjustments made to the works estimate throughout the lease term and the final bill will only be known once the works are completed. In the end, the dilapidation costs could be higher or lower than the estimate and an accounting adjustment will be required.

If the provision ends up being in excess of the final bill, the difference is added back to taxable income and taxed in the year of the works. If the provision is less than required for dilapidation works then any actual additional expenditure can be deducted within the year the works are completed.

Dilapidations can be complex area of finance and law, but in reality preparedness is key. If sufficient provisions are made to cover the cost of the reinstatement works throughout the term of the lease there should be no expensive surprises at its expiry.