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The Free Hrblock
Free hrblock 3. Free hrblock Rent Expense Table of Contents Introduction Topics - This chapter discusses: RentConditional sales contract. Free hrblock Leveraged leases. Free hrblock Leveraged leases of limited-use property. Free hrblock Taxes on Leased Property Cost of Getting a Lease Improvements by Lessee Capitalizing Rent Expenses Introduction This chapter discusses the tax treatment of rent or lease payments you make for property you use in your business but do not own. Free hrblock It also discusses how to treat other kinds of payments you make that are related to your use of this property. Free hrblock These include payments you make for taxes on the property. Free hrblock Topics - This chapter discusses: The definition of rent Taxes on leased property The cost of getting a lease Improvements by the lessee Capitalizing rent expenses Rent Rent is any amount you pay for the use of property you do not own. Free hrblock In general, you can deduct rent as an expense only if the rent is for property you use in your trade or business. Free hrblock If you have or will receive equity in or title to the property, the rent is not deductible. Free hrblock Unreasonable rent. Free hrblock You cannot take a rental deduction for unreasonable rent. Free hrblock Ordinarily, the issue of reasonableness arises only if you and the lessor are related. Free hrblock Rent paid to a related person is reasonable if it is the same amount you would pay to a stranger for use of the same property. Free hrblock Rent is not unreasonable just because it is figured as a percentage of gross sales. Free hrblock For examples of related persons, see Related persons in chapter 2, Publication 544. Free hrblock Rent on your home. Free hrblock If you rent your home and use part of it as your place of business, you may be able to deduct the rent you pay for that part. Free hrblock You must meet the requirements for business use of your home. Free hrblock For more information, see Business use of your home in chapter 1. Free hrblock Rent paid in advance. Free hrblock Generally, rent paid in your trade or business is deductible in the year paid or accrued. Free hrblock If you pay rent in advance, you can deduct only the amount that applies to your use of the rented property during the tax year. Free hrblock You can deduct the rest of your payment only over the period to which it applies. Free hrblock Example 1. Free hrblock You are a calendar year taxpayer and you leased a building for 5 years beginning July 1. Free hrblock Your rent is $12,000 per year. Free hrblock You paid the first year's rent ($12,000) on June 30. Free hrblock You can deduct only $6,000 (6/12 × $12,000) for the rent that applies to the first year. Free hrblock Example 2. Free hrblock You are a calendar year taxpayer. Free hrblock Last January you leased property for 3 years for $6,000 a year. Free hrblock You paid the full $18,000 (3 × $6,000) during the first year of the lease. Free hrblock Each year you can deduct only $6,000, the part of the lease that applies to that year. Free hrblock Canceling a lease. Free hrblock You generally can deduct as rent an amount you pay to cancel a business lease. Free hrblock Lease or purchase. Free hrblock There may be instances in which you must determine whether your payments are for rent or for the purchase of the property. Free hrblock You must first determine whether your agreement is a lease or a conditional sales contract. Free hrblock Payments made under a conditional sales contract are not deductible as rent expense. Free hrblock Conditional sales contract. Free hrblock Whether an agreement is a conditional sales contract depends on the intent of the parties. Free hrblock Determine intent based on the provisions of the agreement and the facts and circumstances that exist when you make the agreement. Free hrblock No single test, or special combination of tests, always applies. Free hrblock However, in general, an agreement may be considered a conditional sales contract rather than a lease if any of the following is true. Free hrblock The agreement applies part of each payment toward an equity interest you will receive. Free hrblock You get title to the property after you make a stated amount of required payments. Free hrblock The amount you must pay to use the property for a short time is a large part of the amount you would pay to get title to the property. Free hrblock You pay much more than the current fair rental value of the property. Free hrblock You have an option to buy the property at a nominal price compared to the value of the property when you may exercise the option. Free hrblock Determine this value when you make the agreement. Free hrblock You have an option to buy the property at a nominal price compared to the total amount you have to pay under the agreement. Free hrblock The agreement designates part of the payments as interest, or that part is easy to recognize as interest. Free hrblock Leveraged leases. Free hrblock Leveraged lease transactions may not be considered leases. Free hrblock Leveraged leases generally involve three parties: a lessor, a lessee, and a lender to the lessor. Free hrblock Usually the lease term covers a large part of the useful life of the leased property, and the lessee's payments to the lessor are enough to cover the lessor's payments to the lender. Free hrblock If you plan to take part in what appears to be a leveraged lease, you may want to get an advance ruling. Free hrblock Revenue Procedure 2001-28 on page 1156 of Internal Revenue Bulletin 2001-19 contains the guidelines the IRS will use to determine if a leveraged lease is a lease for federal income tax purposes. Free hrblock Revenue Procedure 2001-29 on page 1160 of the same Internal Revenue Bulletin provides the information required to be furnished in a request for an advance ruling on a leveraged lease transaction. Free hrblock Internal Revenue Bulletin 2001-19 is available at www. Free hrblock irs. Free hrblock gov/pub/irs-irbs/irb01-19. Free hrblock pdf. Free hrblock In general, Revenue Procedure 2001-28 provides that, for advance ruling purposes only, the IRS will consider the lessor in a leveraged lease transaction to be the owner of the property and the transaction to be a valid lease if all the factors in the revenue procedure are met, including the following. Free hrblock The lessor must maintain a minimum unconditional “at risk” equity investment in the property (at least 20% of the cost of the property) during the entire lease term. Free hrblock The lessee may not have a contractual right to buy the property from the lessor at less than fair market value when the right is exercised. Free hrblock The lessee may not invest in the property, except as provided by Revenue Procedure 2001-28. Free hrblock The lessee may not lend any money to the lessor to buy the property or guarantee the loan used by the lessor to buy the property. Free hrblock The lessor must show that it expects to receive a profit apart from the tax deductions, allowances, credits, and other tax attributes. Free hrblock The IRS may charge you a user fee for issuing a tax ruling. Free hrblock For more information, see Revenue Procedure 2014-1 available at www. Free hrblock irs. Free hrblock gov/irb/2014-1_IRB/ar05. Free hrblock html. Free hrblock Leveraged leases of limited-use property. Free hrblock The IRS will not issue advance rulings on leveraged leases of so-called limited-use property. Free hrblock Limited-use property is property not expected to be either useful to or usable by a lessor at the end of the lease term except for continued leasing or transfer to a lessee. Free hrblock See Revenue Procedure 2001-28 for examples of limited-use property and property that is not limited-use property. Free hrblock Leases over $250,000. Free hrblock Special rules are provided for certain leases of tangible property. Free hrblock The rules apply if the lease calls for total payments of more than $250,000 and any of the following apply. Free hrblock Rents increase during the lease. Free hrblock Rents decrease during the lease. Free hrblock Rents are deferred (rent is payable after the end of the calendar year following the calendar year in which the use occurs and the rent is allocated). Free hrblock Rents are prepaid (rent is payable before the end of the calendar year preceding the calendar year in which the use occurs and the rent is allocated). Free hrblock These rules do not apply if your lease specifies equal amounts of rent for each month in the lease term and all rent payments are due in the calendar year to which the rent relates (or in the preceding or following calendar year). Free hrblock Generally, if the special rules apply, you must use an accrual method of accounting (and time value of money principles) for your rental expenses, regardless of your overall method of accounting. Free hrblock In addition, in certain cases in which the IRS has determined that a lease was designed to achieve tax avoidance, you must take rent and stated or imputed interest into account under a constant rental accrual method in which the rent is treated as accruing ratably over the entire lease term. Free hrblock For details, see section 467 of the Internal Revenue Code. Free hrblock Taxes on Leased Property If you lease business property, you can deduct as additional rent any taxes you have to pay to or for the lessor. Free hrblock When you can deduct these taxes as additional rent depends on your accounting method. Free hrblock Cash method. Free hrblock If you use the cash method of accounting, you can deduct the taxes as additional rent only for the tax year in which you pay them. Free hrblock Accrual method. Free hrblock If you use an accrual method of accounting, you can deduct taxes as additional rent for the tax year in which you can determine all the following. Free hrblock That you have a liability for taxes on the leased property. Free hrblock How much the liability is. Free hrblock That economic performance occurred. Free hrblock The liability and amount of taxes are determined by state or local law and the lease agreement. Free hrblock Economic performance occurs as you use the property. Free hrblock Example 1. Free hrblock Oak Corporation is a calendar year taxpayer that uses an accrual method of accounting. Free hrblock Oak leases land for use in its business. Free hrblock Under state law, owners of real property become liable (incur a lien on the property) for real estate taxes for the year on January 1 of that year. Free hrblock However, they do not have to pay these taxes until July 1 of the next year (18 months later) when tax bills are issued. Free hrblock Under the terms of the lease, Oak becomes liable for the real estate taxes in the later year when the tax bills are issued. Free hrblock If the lease ends before the tax bill for a year is issued, Oak is not liable for the taxes for that year. Free hrblock Oak cannot deduct the real estate taxes as rent until the tax bill is issued. Free hrblock This is when Oak's liability under the lease becomes fixed. Free hrblock Example 2. Free hrblock The facts are the same as in Example 1 except that, according to the terms of the lease, Oak becomes liable for the real estate taxes when the owner of the property becomes liable for them. Free hrblock As a result, Oak will deduct the real estate taxes as rent on its tax return for the earlier year. Free hrblock This is the year in which Oak's liability under the lease becomes fixed. Free hrblock Cost of Getting a Lease You may either enter into a new lease with the lessor of the property or get an existing lease from another lessee. Free hrblock Very often when you get an existing lease from another lessee, you must pay the previous lessee money to get the lease, besides having to pay the rent on the lease. Free hrblock If you get an existing lease on property or equipment for your business, you generally must amortize any amount you pay to get that lease over the remaining term of the lease. Free hrblock For example, if you pay $10,000 to get a lease and there are 10 years remaining on the lease with no option to renew, you can deduct $1,000 each year. Free hrblock The cost of getting an existing lease of tangible property is not subject to the amortization rules for section 197 intangibles discussed in chapter 8. Free hrblock Option to renew. Free hrblock The term of the lease for amortization includes all renewal options plus any other period for which you and the lessor reasonably expect the lease to be renewed. Free hrblock However, this applies only if less than 75% of the cost of getting the lease is for the term remaining on the purchase date (not including any period for which you may choose to renew, extend, or continue the lease). Free hrblock Allocate the lease cost to the original term and any option term based on the facts and circumstances. Free hrblock In some cases, it may be appropriate to make the allocation using a present value computation. Free hrblock For more information, see Regulations section 1. Free hrblock 178-1(b)(5). Free hrblock Example 1. Free hrblock You paid $10,000 to get a lease with 20 years remaining on it and two options to renew for 5 years each. Free hrblock Of this cost, you paid $7,000 for the original lease and $3,000 for the renewal options. Free hrblock Because $7,000 is less than 75% of the total $10,000 cost of the lease (or $7,500), you must amortize the $10,000 over 30 years. Free hrblock That is the remaining life of your present lease plus the periods for renewal. Free hrblock Example 2. Free hrblock The facts are the same as in Example 1, except that you paid $8,000 for the original lease and $2,000 for the renewal options. Free hrblock You can amortize the entire $10,000 over the 20-year remaining life of the original lease. Free hrblock The $8,000 cost of getting the original lease was not less than 75% of the total cost of the lease (or $7,500). Free hrblock Cost of a modification agreement. Free hrblock You may have to pay an additional “rent” amount over part of the lease period to change certain provisions in your lease. Free hrblock You must capitalize these payments and amortize them over the remaining period of the lease. Free hrblock You cannot deduct the payments as additional rent, even if they are described as rent in the agreement. Free hrblock Example. Free hrblock You are a calendar year taxpayer and sign a 20-year lease to rent part of a building starting on January 1. Free hrblock However, before you occupy it, you decide that you really need less space. Free hrblock The lessor agrees to reduce your rent from $7,000 to $6,000 per year and to release the excess space from the original lease. Free hrblock In exchange, you agree to pay an additional rent amount of $3,000, payable in 60 monthly installments of $50 each. Free hrblock You must capitalize the $3,000 and amortize it over the 20-year term of the lease. Free hrblock Your amortization deduction each year will be $150 ($3,000 ÷ 20). Free hrblock You cannot deduct the $600 (12 × $50) that you will pay during each of the first 5 years as rent. Free hrblock Commissions, bonuses, and fees. Free hrblock Commissions, bonuses, fees, and other amounts you pay to get a lease on property you use in your business are capital costs. Free hrblock You must amortize these costs over the term of the lease. Free hrblock Loss on merchandise and fixtures. Free hrblock If you sell at a loss merchandise and fixtures that you bought solely to get a lease, the loss is a cost of getting the lease. Free hrblock You must capitalize the loss and amortize it over the remaining term of the lease. Free hrblock Improvements by Lessee If you add buildings or make other permanent improvements to leased property, depreciate the cost of the improvements using the modified accelerated cost recovery system (MACRS). Free hrblock Depreciate the property over its appropriate recovery period. Free hrblock You cannot amortize the cost over the remaining term of the lease. Free hrblock If you do not keep the improvements when you end the lease, figure your gain or loss based on your adjusted basis in the improvements at that time. Free hrblock For more information, see the discussion of MACRS in Publication 946, How To Depreciate Property. Free hrblock Assignment of a lease. Free hrblock If a long-term lessee who makes permanent improvements to land later assigns all lease rights to you for money and you pay the rent required by the lease, the amount you pay for the assignment is a capital investment. Free hrblock If the rental value of the leased land increased since the lease began, part of your capital investment is for that increase in the rental value. Free hrblock The rest is for your investment in the permanent improvements. Free hrblock The part that is for the increased rental value of the land is a cost of getting a lease, and you amortize it over the remaining term of the lease. Free hrblock You can depreciate the part that is for your investment in the improvements over the recovery period of the property as discussed earlier, without regard to the lease term. Free hrblock Capitalizing Rent Expenses Under the uniform capitalization rules, you must capitalize the direct costs and part of the indirect costs for certain production or resale activities. Free hrblock Include these costs in the basis of property you produce or acquire for resale, rather than claiming them as a current deduction. Free hrblock You recover the costs through depreciation, amortization, or cost of goods sold when you use, sell, or otherwise dispose of the property. Free hrblock Indirect costs include amounts incurred for renting or leasing equipment, facilities, or land. Free hrblock Uniform capitalization rules. Free hrblock You may be subject to the uniform capitalization rules if you do any of the following, unless the property is produced for your use other than in a business or an activity carried on for profit. Free hrblock Produce real property or tangible personal property. Free hrblock For this purpose, tangible personal property includes a film, sound recording, video tape, book, or similar property. Free hrblock Acquire property for resale. Free hrblock However, these rules do not apply to the following property. Free hrblock Personal property you acquire for resale if your average annual gross receipts are $10 million or less for the 3 prior tax years. Free hrblock Property you produce if you meet either of the following conditions. Free hrblock Your indirect costs of producing the property are $200,000 or less. Free hrblock You use the cash method of accounting and do not account for inventories. Free hrblock Example 1. Free hrblock You rent construction equipment to build a storage facility. Free hrblock If you are subject to the uniform capitalization rules, you must capitalize as part of the cost of the building the rent you paid for the equipment. Free hrblock You recover your cost by claiming a deduction for depreciation on the building. Free hrblock Example 2. Free hrblock You rent space in a facility to conduct your business of manufacturing tools. Free hrblock If you are subject to the uniform capitalization rules, you must include the rent you paid to occupy the facility in the cost of the tools you produce. Free hrblock More information. Free hrblock For more information on these rules, see Uniform Capitalization Rules in Publication 538 and the regulations under Internal Revenue Code section 263A. Free hrblock Prev Up Next Home More Online Publications