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Www irs gov e file 3. Www irs gov e file   Rent Expense Table of Contents Introduction Topics - This chapter discusses: RentConditional sales contract. Www irs gov e file Leveraged leases. Www irs gov e file Leveraged leases of limited-use property. Www irs gov e file 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 irs gov e file It also discusses how to treat other kinds of payments you make that are related to your use of this property. Www irs gov e file These include payments you make for taxes on the property. Www irs gov e file 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 irs gov e file In general, you can deduct rent as an expense only if the rent is for property you use in your trade or business. Www irs gov e file If you have or will receive equity in or title to the property, the rent is not deductible. Www irs gov e file Unreasonable rent. Www irs gov e file   You cannot take a rental deduction for unreasonable rent. Www irs gov e file Ordinarily, the issue of reasonableness arises only if you and the lessor are related. Www irs gov e file 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 irs gov e file Rent is not unreasonable just because it is figured as a percentage of gross sales. Www irs gov e file For examples of related persons, see Related persons in chapter 2, Publication 544. Www irs gov e file Rent on your home. Www irs gov e file   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 irs gov e file You must meet the requirements for business use of your home. Www irs gov e file For more information, see Business use of your home in chapter 1. Www irs gov e file Rent paid in advance. Www irs gov e file   Generally, rent paid in your trade or business is deductible in the year paid or accrued. Www irs gov e file 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 irs gov e file You can deduct the rest of your payment only over the period to which it applies. Www irs gov e file Example 1. Www irs gov e file You are a calendar year taxpayer and you leased a building for 5 years beginning July 1. Www irs gov e file Your rent is $12,000 per year. Www irs gov e file You paid the first year's rent ($12,000) on June 30. Www irs gov e file You can deduct only $6,000 (6/12 × $12,000) for the rent that applies to the first year. Www irs gov e file Example 2. Www irs gov e file You are a calendar year taxpayer. Www irs gov e file Last January you leased property for 3 years for $6,000 a year. Www irs gov e file You paid the full $18,000 (3 × $6,000) during the first year of the lease. Www irs gov e file Each year you can deduct only $6,000, the part of the lease that applies to that year. Www irs gov e file Canceling a lease. Www irs gov e file   You generally can deduct as rent an amount you pay to cancel a business lease. Www irs gov e file Lease or purchase. Www irs gov e file   There may be instances in which you must determine whether your payments are for rent or for the purchase of the property. Www irs gov e file You must first determine whether your agreement is a lease or a conditional sales contract. Www irs gov e file Payments made under a conditional sales contract are not deductible as rent expense. Www irs gov e file Conditional sales contract. Www irs gov e file   Whether an agreement is a conditional sales contract depends on the intent of the parties. Www irs gov e file Determine intent based on the provisions of the agreement and the facts and circumstances that exist when you make the agreement. Www irs gov e file No single test, or special combination of tests, always applies. Www irs gov e file However, in general, an agreement may be considered a conditional sales contract rather than a lease if any of the following is true. Www irs gov e file The agreement applies part of each payment toward an equity interest you will receive. Www irs gov e file You get title to the property after you make a stated amount of required payments. Www irs gov e file 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 irs gov e file You pay much more than the current fair rental value of the property. Www irs gov e file 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 irs gov e file Determine this value when you make the agreement. Www irs gov e file 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 irs gov e file The agreement designates part of the payments as interest, or that part is easy to recognize as interest. Www irs gov e file Leveraged leases. Www irs gov e file   Leveraged lease transactions may not be considered leases. Www irs gov e file Leveraged leases generally involve three parties: a lessor, a lessee, and a lender to the lessor. Www irs gov e file 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 irs gov e file   If you plan to take part in what appears to be a leveraged lease, you may want to get an advance ruling. Www irs gov e file 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 irs gov e file 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 irs gov e file Internal Revenue Bulletin 2001-19 is available at www. Www irs gov e file irs. Www irs gov e file gov/pub/irs-irbs/irb01-19. Www irs gov e file pdf. Www irs gov e file   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 irs gov e file 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 irs gov e file 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 irs gov e file The lessee may not invest in the property, except as provided by Revenue Procedure 2001-28. Www irs gov e file 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 irs gov e file 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 e file   The IRS may charge you a user fee for issuing a tax ruling. Www irs gov e file For more information, see Revenue Procedure 2014-1 available at  www. Www irs gov e file irs. Www irs gov e file gov/irb/2014-1_IRB/ar05. Www irs gov e file html. Www irs gov e file Leveraged leases of limited-use property. Www irs gov e file   The IRS will not issue advance rulings on leveraged leases of so-called limited-use property. Www irs gov e file 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 irs gov e file See Revenue Procedure 2001-28 for examples of limited-use property and property that is not limited-use property. Www irs gov e file Leases over $250,000. Www irs gov e file   Special rules are provided for certain leases of tangible property. Www irs gov e file The rules apply if the lease calls for total payments of more than $250,000 and any of the following apply. Www irs gov e file Rents increase during the lease. Www irs gov e file Rents decrease during the lease. Www irs gov e file 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 irs gov e file 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 irs gov e file 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 irs gov e file   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 irs gov e file 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 irs gov e file For details, see section 467 of the Internal Revenue Code. Www irs gov e file 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 irs gov e file When you can deduct these taxes as additional rent depends on your accounting method. Www irs gov e file Cash method. Www irs gov e file   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 irs gov e file Accrual method. Www irs gov e file   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 irs gov e file That you have a liability for taxes on the leased property. Www irs gov e file How much the liability is. Www irs gov e file That economic performance occurred. Www irs gov e file   The liability and amount of taxes are determined by state or local law and the lease agreement. Www irs gov e file Economic performance occurs as you use the property. Www irs gov e file Example 1. Www irs gov e file Oak Corporation is a calendar year taxpayer that uses an accrual method of accounting. Www irs gov e file Oak leases land for use in its business. Www irs gov e file 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 irs gov e file 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 irs gov e file 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 irs gov e file If the lease ends before the tax bill for a year is issued, Oak is not liable for the taxes for that year. Www irs gov e file Oak cannot deduct the real estate taxes as rent until the tax bill is issued. Www irs gov e file This is when Oak's liability under the lease becomes fixed. Www irs gov e file Example 2. Www irs gov e file 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 irs gov e file As a result, Oak will deduct the real estate taxes as rent on its tax return for the earlier year. Www irs gov e file This is the year in which Oak's liability under the lease becomes fixed. Www irs gov e file 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 irs gov e file 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 irs gov e file 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 irs gov e file 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 irs gov e file 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 irs gov e file Option to renew. Www irs gov e file   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 irs gov e file 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 irs gov e file Allocate the lease cost to the original term and any option term based on the facts and circumstances. Www irs gov e file In some cases, it may be appropriate to make the allocation using a present value computation. Www irs gov e file For more information, see Regulations section 1. Www irs gov e file 178-1(b)(5). Www irs gov e file Example 1. Www irs gov e file You paid $10,000 to get a lease with 20 years remaining on it and two options to renew for 5 years each. Www irs gov e file Of this cost, you paid $7,000 for the original lease and $3,000 for the renewal options. Www irs gov e file 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 irs gov e file That is the remaining life of your present lease plus the periods for renewal. Www irs gov e file Example 2. Www irs gov e file 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 irs gov e file You can amortize the entire $10,000 over the 20-year remaining life of the original lease. Www irs gov e file 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 irs gov e file Cost of a modification agreement. Www irs gov e file   You may have to pay an additional “rent” amount over part of the lease period to change certain provisions in your lease. Www irs gov e file You must capitalize these payments and amortize them over the remaining period of the lease. Www irs gov e file You cannot deduct the payments as additional rent, even if they are described as rent in the agreement. Www irs gov e file Example. Www irs gov e file You are a calendar year taxpayer and sign a 20-year lease to rent part of a building starting on January 1. Www irs gov e file However, before you occupy it, you decide that you really need less space. Www irs gov e file 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 irs gov e file In exchange, you agree to pay an additional rent amount of $3,000, payable in 60 monthly installments of $50 each. Www irs gov e file   You must capitalize the $3,000 and amortize it over the 20-year term of the lease. Www irs gov e file Your amortization deduction each year will be $150 ($3,000 ÷ 20). Www irs gov e file You cannot deduct the $600 (12 × $50) that you will pay during each of the first 5 years as rent. Www irs gov e file Commissions, bonuses, and fees. Www irs gov e file   Commissions, bonuses, fees, and other amounts you pay to get a lease on property you use in your business are capital costs. Www irs gov e file You must amortize these costs over the term of the lease. Www irs gov e file Loss on merchandise and fixtures. Www irs gov e file   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 irs gov e file You must capitalize the loss and amortize it over the remaining term of the lease. Www irs gov e file 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 irs gov e file Depreciate the property over its appropriate recovery period. Www irs gov e file You cannot amortize the cost over the remaining term of the lease. Www irs gov e file 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 irs gov e file For more information, see the discussion of MACRS in Publication 946, How To Depreciate Property. Www irs gov e file Assignment of a lease. Www irs gov e file   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 irs gov e file 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 irs gov e file The rest is for your investment in the permanent improvements. Www irs gov e file   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 irs gov e file 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 irs gov e file 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 irs gov e file Include these costs in the basis of property you produce or acquire for resale, rather than claiming them as a current deduction. Www irs gov e file You recover the costs through depreciation, amortization, or cost of goods sold when you use, sell, or otherwise dispose of the property. Www irs gov e file Indirect costs include amounts incurred for renting or leasing equipment, facilities, or land. Www irs gov e file Uniform capitalization rules. Www irs gov e file   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 irs gov e file Produce real property or tangible personal property. Www irs gov e file For this purpose, tangible personal property includes a film, sound recording, video tape, book, or similar property. Www irs gov e file Acquire property for resale. Www irs gov e file However, these rules do not apply to the following property. Www irs gov e file Personal property you acquire for resale if your average annual gross receipts are $10 million or less for the 3 prior tax years. Www irs gov e file Property you produce if you meet either of the following conditions. Www irs gov e file Your indirect costs of producing the property are $200,000 or less. Www irs gov e file You use the cash method of accounting and do not account for inventories. Www irs gov e file Example 1. Www irs gov e file You rent construction equipment to build a storage facility. Www irs gov e file 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 irs gov e file You recover your cost by claiming a deduction for depreciation on the building. Www irs gov e file Example 2. Www irs gov e file You rent space in a facility to conduct your business of manufacturing tools. Www irs gov e file 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 irs gov e file More information. Www irs gov e file   For more information on these rules, see Uniform Capitalization Rules in Publication 538 and the regulations under Internal Revenue Code section 263A. Www irs gov e file Prev  Up  Next   Home   More Online Publications