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Www h&r block 3. Www h&r block   Rent Expense Table of Contents Introduction Topics - This chapter discusses: RentConditional sales contract. Www h&r block Leveraged leases. Www h&r block Leveraged leases of limited-use property. Www h&r block 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. Www h&r block It also discusses how to treat other kinds of payments you make that are related to your use of this property. Www h&r block These include payments you make for taxes on the property. Www h&r block 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. Www h&r block In general, you can deduct rent as an expense only if the rent is for property you use in your trade or business. Www h&r block If you have or will receive equity in or title to the property, the rent is not deductible. Www h&r block Unreasonable rent. Www h&r block   You cannot take a rental deduction for unreasonable rent. Www h&r block Ordinarily, the issue of reasonableness arises only if you and the lessor are related. Www h&r block 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. Www h&r block Rent is not unreasonable just because it is figured as a percentage of gross sales. Www h&r block For examples of related persons, see Related persons in chapter 2, Publication 544. Www h&r block Rent on your home. Www h&r block   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. Www h&r block You must meet the requirements for business use of your home. Www h&r block For more information, see Business use of your home in chapter 1. Www h&r block Rent paid in advance. Www h&r block   Generally, rent paid in your trade or business is deductible in the year paid or accrued. Www h&r block 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. Www h&r block You can deduct the rest of your payment only over the period to which it applies. Www h&r block Example 1. Www h&r block You are a calendar year taxpayer and you leased a building for 5 years beginning July 1. Www h&r block Your rent is $12,000 per year. Www h&r block You paid the first year's rent ($12,000) on June 30. Www h&r block You can deduct only $6,000 (6/12 × $12,000) for the rent that applies to the first year. Www h&r block Example 2. Www h&r block You are a calendar year taxpayer. Www h&r block Last January you leased property for 3 years for $6,000 a year. Www h&r block You paid the full $18,000 (3 × $6,000) during the first year of the lease. Www h&r block Each year you can deduct only $6,000, the part of the lease that applies to that year. Www h&r block Canceling a lease. Www h&r block   You generally can deduct as rent an amount you pay to cancel a business lease. Www h&r block Lease or purchase. Www h&r block   There may be instances in which you must determine whether your payments are for rent or for the purchase of the property. Www h&r block You must first determine whether your agreement is a lease or a conditional sales contract. Www h&r block Payments made under a conditional sales contract are not deductible as rent expense. Www h&r block Conditional sales contract. Www h&r block   Whether an agreement is a conditional sales contract depends on the intent of the parties. Www h&r block Determine intent based on the provisions of the agreement and the facts and circumstances that exist when you make the agreement. Www h&r block No single test, or special combination of tests, always applies. Www h&r block However, in general, an agreement may be considered a conditional sales contract rather than a lease if any of the following is true. Www h&r block The agreement applies part of each payment toward an equity interest you will receive. Www h&r block You get title to the property after you make a stated amount of required payments. Www h&r block 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. Www h&r block You pay much more than the current fair rental value of the property. Www h&r block 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. Www h&r block Determine this value when you make the agreement. Www h&r block You have an option to buy the property at a nominal price compared to the total amount you have to pay under the agreement. Www h&r block The agreement designates part of the payments as interest, or that part is easy to recognize as interest. Www h&r block Leveraged leases. Www h&r block   Leveraged lease transactions may not be considered leases. Www h&r block Leveraged leases generally involve three parties: a lessor, a lessee, and a lender to the lessor. Www h&r block 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. Www h&r block   If you plan to take part in what appears to be a leveraged lease, you may want to get an advance ruling. Www h&r block 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. Www h&r block 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. Www h&r block Internal Revenue Bulletin 2001-19 is available at www. Www h&r block irs. Www h&r block gov/pub/irs-irbs/irb01-19. Www h&r block pdf. Www h&r block   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. Www h&r block 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. Www h&r block 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. Www h&r block The lessee may not invest in the property, except as provided by Revenue Procedure 2001-28. Www h&r block 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. Www h&r block The lessor must show that it expects to receive a profit apart from the tax deductions, allowances, credits, and other tax attributes. Www h&r block   The IRS may charge you a user fee for issuing a tax ruling. Www h&r block For more information, see Revenue Procedure 2014-1 available at  www. Www h&r block irs. Www h&r block gov/irb/2014-1_IRB/ar05. Www h&r block html. Www h&r block Leveraged leases of limited-use property. Www h&r block   The IRS will not issue advance rulings on leveraged leases of so-called limited-use property. Www h&r block 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. Www h&r block See Revenue Procedure 2001-28 for examples of limited-use property and property that is not limited-use property. Www h&r block Leases over $250,000. Www h&r block   Special rules are provided for certain leases of tangible property. Www h&r block The rules apply if the lease calls for total payments of more than $250,000 and any of the following apply. Www h&r block Rents increase during the lease. Www h&r block Rents decrease during the lease. Www h&r block 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). Www h&r block 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). Www h&r block 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). Www h&r block   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. Www h&r block 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. Www h&r block For details, see section 467 of the Internal Revenue Code. Www h&r block 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. Www h&r block When you can deduct these taxes as additional rent depends on your accounting method. Www h&r block Cash method. Www h&r block   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. Www h&r block Accrual method. Www h&r block   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. Www h&r block That you have a liability for taxes on the leased property. Www h&r block How much the liability is. Www h&r block That economic performance occurred. Www h&r block   The liability and amount of taxes are determined by state or local law and the lease agreement. Www h&r block Economic performance occurs as you use the property. Www h&r block Example 1. Www h&r block Oak Corporation is a calendar year taxpayer that uses an accrual method of accounting. Www h&r block Oak leases land for use in its business. Www h&r block 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. Www h&r block However, they do not have to pay these taxes until July 1 of the next year (18 months later) when tax bills are issued. Www h&r block Under the terms of the lease, Oak becomes liable for the real estate taxes in the later year when the tax bills are issued. Www h&r block If the lease ends before the tax bill for a year is issued, Oak is not liable for the taxes for that year. Www h&r block Oak cannot deduct the real estate taxes as rent until the tax bill is issued. Www h&r block This is when Oak's liability under the lease becomes fixed. Www h&r block Example 2. Www h&r block 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. Www h&r block As a result, Oak will deduct the real estate taxes as rent on its tax return for the earlier year. Www h&r block This is the year in which Oak's liability under the lease becomes fixed. Www h&r block 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. Www h&r block 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. Www h&r block 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. Www h&r block 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. Www h&r block 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. Www h&r block Option to renew. Www h&r block   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. Www h&r block 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). Www h&r block Allocate the lease cost to the original term and any option term based on the facts and circumstances. Www h&r block In some cases, it may be appropriate to make the allocation using a present value computation. Www h&r block For more information, see Regulations section 1. Www h&r block 178-1(b)(5). Www h&r block Example 1. Www h&r block You paid $10,000 to get a lease with 20 years remaining on it and two options to renew for 5 years each. Www h&r block Of this cost, you paid $7,000 for the original lease and $3,000 for the renewal options. Www h&r block 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. Www h&r block That is the remaining life of your present lease plus the periods for renewal. Www h&r block Example 2. Www h&r block 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. Www h&r block You can amortize the entire $10,000 over the 20-year remaining life of the original lease. Www h&r block The $8,000 cost of getting the original lease was not less than 75% of the total cost of the lease (or $7,500). Www h&r block Cost of a modification agreement. Www h&r block   You may have to pay an additional “rent” amount over part of the lease period to change certain provisions in your lease. Www h&r block You must capitalize these payments and amortize them over the remaining period of the lease. Www h&r block You cannot deduct the payments as additional rent, even if they are described as rent in the agreement. Www h&r block Example. Www h&r block You are a calendar year taxpayer and sign a 20-year lease to rent part of a building starting on January 1. Www h&r block However, before you occupy it, you decide that you really need less space. Www h&r block 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. Www h&r block In exchange, you agree to pay an additional rent amount of $3,000, payable in 60 monthly installments of $50 each. Www h&r block   You must capitalize the $3,000 and amortize it over the 20-year term of the lease. Www h&r block Your amortization deduction each year will be $150 ($3,000 ÷ 20). Www h&r block You cannot deduct the $600 (12 × $50) that you will pay during each of the first 5 years as rent. Www h&r block Commissions, bonuses, and fees. Www h&r block   Commissions, bonuses, fees, and other amounts you pay to get a lease on property you use in your business are capital costs. Www h&r block You must amortize these costs over the term of the lease. Www h&r block Loss on merchandise and fixtures. Www h&r block   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. Www h&r block You must capitalize the loss and amortize it over the remaining term of the lease. Www h&r block 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). Www h&r block Depreciate the property over its appropriate recovery period. Www h&r block You cannot amortize the cost over the remaining term of the lease. Www h&r block 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. Www h&r block For more information, see the discussion of MACRS in Publication 946, How To Depreciate Property. Www h&r block Assignment of a lease. Www h&r block   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. Www h&r block 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. Www h&r block The rest is for your investment in the permanent improvements. Www h&r block   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. Www h&r block 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. Www h&r block 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. Www h&r block Include these costs in the basis of property you produce or acquire for resale, rather than claiming them as a current deduction. Www h&r block You recover the costs through depreciation, amortization, or cost of goods sold when you use, sell, or otherwise dispose of the property. Www h&r block Indirect costs include amounts incurred for renting or leasing equipment, facilities, or land. Www h&r block Uniform capitalization rules. Www h&r block   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. Www h&r block Produce real property or tangible personal property. Www h&r block For this purpose, tangible personal property includes a film, sound recording, video tape, book, or similar property. Www h&r block Acquire property for resale. Www h&r block However, these rules do not apply to the following property. Www h&r block Personal property you acquire for resale if your average annual gross receipts are $10 million or less for the 3 prior tax years. Www h&r block Property you produce if you meet either of the following conditions. Www h&r block Your indirect costs of producing the property are $200,000 or less. Www h&r block You use the cash method of accounting and do not account for inventories. Www h&r block Example 1. Www h&r block You rent construction equipment to build a storage facility. Www h&r block 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. Www h&r block You recover your cost by claiming a deduction for depreciation on the building. Www h&r block Example 2. Www h&r block You rent space in a facility to conduct your business of manufacturing tools. Www h&r block 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. Www h&r block More information. Www h&r block   For more information on these rules, see Uniform Capitalization Rules in Publication 538 and the regulations under Internal Revenue Code section 263A. Www h&r block Prev  Up  Next   Home   More Online Publications
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Www h&r block Index A Affected taxpayer, Affected taxpayer. Www h&r block B Book inventories, charitable deduction for, Charitable Deduction for Contributions of Book Inventories to Public Schools C Cancellation of indebtedness, Exclusion of Certain Cancellations of Indebtedness by Reason of Hurricane Katrina Casualty and theft losses, Casualty and Theft Losses Charitable contributions, Temporary Suspension of Limits on Charitable Contributions Charitable deduction: Book inventory, Charitable Deduction for Contributions of Book Inventories to Public Schools Food inventory, Charitable Deduction for Contributions of Food Inventory Child tax credit, Earned Income Credit and Child Tax Credit Clean-up costs, Demolition and Clean-up Costs Copy of tax return, request for, Request for copy of tax return. Www h&r block Core disaster area, Gulf Opportunity (GO) Zone (Core Disaster Area) Covered disaster area: Katrina, Katrina Covered Disaster Area Rita, Hurricane Rita Disaster Area (Rita Covered Disaster Area) Wilma, Wilma Covered Disaster Area Credits: Child tax, Earned Income Credit and Child Tax Credit Earned income, Earned Income Credit and Child Tax Credit Education, Education Credits Employee retention, Employee Retention Credit Hurricane Katrina housing, Hurricane Katrina Housing Credit Rehabilitation tax, Increase in Rehabilitation Tax Credit Work opportunity, Work Opportunity Credit D Deadlines, extended, Extended Tax Deadlines Demolition costs, Demolition and Clean-up Costs Depreciation: Qualified GO Zone property, Qualified GO Zone property. Www h&r block Special allowance, Special Depreciation Allowance Disaster area: Hurricane Katrina, Hurricane Katrina Disaster Area Hurricane Rita, Hurricane Rita Disaster Area (Rita Covered Disaster Area) Hurricane Wilma, Hurricane Wilma Disaster Area Distributions: Home purchase or construction, Repayment of Qualified Distributions for the Purchase or Construction of a Main Home Qualified hurricane, Qualified hurricane distribution. Www h&r block Repayment of, Repayment of Qualified Hurricane Distributions Taxation of, Taxation of Qualified Hurricane Distributions E Earned income credit, Earned Income Credit and Child Tax Credit Education credits, Education Credits Eligible retirement plan, Eligible retirement plan. Www h&r block Employee retention credit, Employee Retention Credit Exemption, additional for housing, Additional Exemption for Housing Individuals Displaced by Hurricane Katrina F Federal mortgage subsidy, recapture of, Recapture of Federal Mortgage Subsidy Food inventory, charitable deduction for, Charitable Deduction for Contributions of Food Inventory G Gulf Opportunity (GO) Zone, Gulf Opportunity (GO) Zone (Core Disaster Area) H Help: How to get, How To Get Tax Help Phone number, How To Get Tax Help Special IRS assistance, How To Get Tax Help Website, How To Get Tax Help Hope credit (see Education credits) Hurricane Katrina disaster area, Hurricane Katrina Disaster Area Hurricane Katrina housing credit, Hurricane Katrina Housing Credit Hurricane Rita disaster area, Hurricane Rita Disaster Area (Rita Covered Disaster Area) Hurricane Wilma disaster area, Hurricane Wilma Disaster Area I Involuntary conversion (see Replacement period for nonrecognition of gain) IRAs and other retirement plans, IRAs and Other Retirement Plans L Lifetime learning credit (see Education credits) M Mileage reimbursements, charitable volunteers, Mileage Reimbursements to Charitable Volunteers N Net operating losses, Net Operating Losses Q Qualified GO Zone loss, Qualified GO Zone loss. Www h&r block Qualified hurricane distribution, Qualified hurricane distribution. Www h&r block R Reforestation costs, Reforestation Costs Rehabilitation tax credit, Increase in Rehabilitation Tax Credit Relocation, temporary, Tax Relief for Temporary Relocation Replacement period for nonrecognition of gain, Replacement Period for Nonrecognition of Gain Retirement plan, eligible, Eligible retirement plan. Www h&r block Retirement plans, IRAs and Other Retirement Plans Rita GO Zone, Rita GO Zone S Section 179 deduction, Increased Section 179 Deduction Standard mileage rate, charitable use, Standard Mileage Rate for Charitable Use of Vehicles T Tax return: Request for copy, Request for copy of tax return. Www h&r block Request for transcript, Request for transcript of tax return. Www h&r block Taxpayer Advocate, Contacting your Taxpayer Advocate. Www h&r block Temporary relocation, Tax Relief for Temporary Relocation Theft losses, Casualty and Theft Losses Timber: 5-year NOL carryback, 5-year NOL carryback of certain timber losses. Www h&r block Reforestation costs, Reforestation Costs Transcript of tax return, request for, Request for transcript of tax return. Www h&r block W Wilma GO Zone, Wilma GO Zone Work opportunity credit, Work Opportunity Credit Prev  Up     Home   More Online Publications