Table of Contents
This chapter discusses the tax treatment of rent or lease payments you make for property you use in your business but do not own. It also discusses how to treat other kinds of payments you make that are related to your use of this property. These include payments you make for taxes on the property.
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The definition of rent
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Taxes on leased property
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The cost of getting a lease
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Improvements by the lessee
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Capitalizing rent expenses
Rent is any amount you pay for the use of property you do not own. In general, you can deduct rent as an expense only if the rent is for property you use in your trade or business. If you have or will receive equity in or title to the property, the rent is not deductible.
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The agreement applies part of each payment toward an equity interest you will receive.
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You get title to the property after you make a stated amount of required payments.
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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.
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You pay much more than the current fair rental value of the property.
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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. Determine this value when you make the agreement.
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You have an option to buy the property at a nominal price compared to the total amount you have to pay under the agreement.
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The agreement designates part of the payments as interest, or that part is easy to recognize as interest.
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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.
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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.
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The lessee may not invest in the property, except as provided by Revenue Procedure 2001-28.
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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.
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The lessor must show that it expects to receive a profit apart from the tax deductions, allowances, credits, and other tax attributes.
www.irs.gov/irb/2012-01_IRB/ar06.html.
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Rents increase during the lease.
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Rents decrease during the lease.
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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).
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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).
If you lease business property, you can deduct as additional rent any taxes you have to pay to or for the lessor. When you can deduct these taxes as additional rent depends on your accounting method.
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That you have a liability for taxes on the leased property.
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How much the liability is.
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That economic performance occurred.
Example 1.
Oak Corporation is a calendar year taxpayer that uses an accrual method of accounting. Oak leases land for use in its business. 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. However, they do not have to pay these taxes until July 1 of the next year (18 months later) when tax bills are issued. Under the terms of the lease, Oak becomes liable for the real estate taxes in the later year when the tax bills are issued. If the lease ends before the tax bill for a year is issued, Oak is not liable for the taxes for that year.
Oak cannot deduct the real estate taxes as rent until the tax bill is issued. This is when Oak's liability under the lease becomes fixed.
Example 2.
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. As a result, Oak will deduct the real estate taxes as rent on its tax return for the earlier year. This is the year in which Oak's liability under the lease becomes fixed.
You may either enter into a new lease with the lessor of the property or get an existing lease from another lessee. 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.
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. 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.
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.
Example 1.
You paid $10,000 to get a lease with 20 years remaining on it and two options to renew for 5 years each. Of this cost, you paid $7,000 for the original lease and $3,000 for the renewal options. 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. That is the remaining life of your present lease plus the periods for renewal.
Example 2.
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. You can amortize the entire $10,000 over the 20-year remaining life of the original lease. The $8,000 cost of getting the original lease was not less than 75% of the total cost of the lease (or $7,500).
Example.
You are a calendar year taxpayer and sign a 20-year lease to rent part of a building starting on January 1. However, before you occupy it, you decide that you really need less space. 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. In exchange, you agree to pay an additional rent amount of $3,000, payable in 60 monthly installments of $50 each.
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). Depreciate the property over its appropriate recovery period. You cannot amortize the cost over the remaining term of the lease.
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.
For more information, see the discussion of MACRS in Publication 946, How To Depreciate Property.
Under the uniform capitalization rules, you must capitalize the direct costs and part of the indirect costs for certain production or resale activities. Include these costs in the basis of property you produce or acquire for resale, rather than claiming them as a current deduction. You recover the costs through depreciation, amortization, or cost of goods sold when you use, sell, or otherwise dispose of the property.
Indirect costs include amounts incurred for renting or leasing equipment, facilities, or land.
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Produce real property or tangible personal property. For this purpose, tangible personal property includes a film, sound recording, video tape, book, or similar property.
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Acquire property for resale.
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Personal property you acquire for resale if your average annual gross receipts are $10 million or less for the 3 prior tax years.
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Property you produce if you meet either of the following conditions.
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Your indirect costs of producing the property are $200,000 or less.
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You use the cash method of accounting and do not account for inventories.
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Example 1.
You rent construction equipment to build a storage facility. 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. You recover your cost by claiming a deduction for depreciation on the building.
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