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, improvements to the property, and getting a lease. There is a discussion about capitalizing (including in the cost of property) certain rent expenses at the end of the chapter.
See chapter 12 for information about getting publications and forms.taxmap/pubs/p535-007.htm#en_us_publink1000243047
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. taxmap/pubs/p535-007.htm#en_us_publink1000243048
You cannot take a rental deduction for unreasonable rent. Ordinarily, the issue of reasonableness arises only if you and the lessor are related. Rent paid to a related person (defined below) is reasonable if it is the same amount you would pay to a stranger for use of the same property. Rent is not unreasonable just because it is figured as a percentage of gross sales. taxmap/pubs/p535-007.htm#en_us_publink1000243049
For this purpose, the following are considered related persons.
- An individual and his or her brothers and sisters, half-brothers, half-sisters, spouse, ancestors (parents, grandparents, etc.), and lineal descendants (children, grandchildren, etc.).
- An individual and a corporation if the individual owns, directly or indirectly, more than 50% in value of the outstanding stock of the corporation.
- Two corporations that are members of the same controlled group as defined in section 267(f) of the Internal Revenue Code.
- A grantor and a fiduciary of any trust.
- Fiduciaries of two separate trusts if the same person is a grantor of both trusts.
- A fiduciary and a beneficiary of the same trust.
- A fiduciary and a beneficiary of two separate trusts if the same person is a grantor of both trusts.
- A fiduciary of a trust and a corporation if the trust or a grantor of the trust owns, directly or indirectly, more than 50% in value of the outstanding stock of the corporation.
- A person and a tax-exempt educational or charitable organization that is controlled directly or indirectly by that person or by members of the family of that person.
- A corporation and a partnership if the same persons own more than 50% in value of the outstanding stock of the corporation and more than 50% of the capital or profits interest in the partnership.
- Two S corporations or an S corporation and a regular corporation if the same persons own more than 50% in value of the outstanding stock of each corporation.
- An executor of an estate and a beneficiary of the estate unless the sale or exchange is in satisfaction of a pecuniary bequest.
To determine whether an individual directly or indirectly owns any of the outstanding stock of a corporation, see Related Persons in Publication 542, Corporations. For rules that apply to transactions between partners and partnerships, see Publication 541, Partnerships.taxmap/pubs/p535-007.htm#en_us_publink1000243050
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. You must meet the requirements for business use of your home. For more information, see Business use of your home in chapter 1. taxmap/pubs/p535-007.htm#en_us_publink1000243051
Generally, rent paid in your trade or business is deductible in the year paid or accrued. 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. You can deduct the rest of your payment only over the period to which it applies. taxmap/pubs/p535-007.htm#en_us_publink1000243052
You are a calendar year taxpayer and you leased a building for 5 years beginning July 1. Your rent is $12,000 per year. You paid the first year's rent ($12,000) on June 30. You can deduct only $6,000 (6/12 × $12,000) for the rent that applies to the first year.taxmap/pubs/p535-007.htm#en_us_publink1000243053
You are a calendar year taxpayer. Last January you leased property for 3 years for $6,000 a year. You paid the full $18,000 (3 × $6,000) during the first year of the lease. Each year you can deduct only $6,000, the part of the lease that applies to that year.taxmap/pubs/p535-007.htm#en_us_publink1000243054
You generally can deduct as rent an amount you pay to cancel a business lease. taxmap/pubs/p535-007.htm#en_us_publink1000243055
There may be instances in which you must determine whether your payments are for rent or for the purchase of the property. You must first determine whether your agreement is a lease or a conditional sales contract. Payments made under a conditional sales contract are not deductible as rent expense. taxmap/pubs/p535-007.htm#en_us_publink1000243056
Whether an agreement is a conditional sales contract depends on the intent of the parties. Determine intent based on the provisions of the agreement and the facts and circumstances that exist when you make the agreement. No single test, or special combination of tests, always applies. However, in general, an agreement may be considered a conditional sales contract rather than a lease if any of the following is true.
- The agreement applies part of each payment toward an equity interest you will receive.
- You get title to the property after you make a stated amount of required payments.
- 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.
- You pay much more than the current fair rental value of the property.
- 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.
- You have an option to buy the property at a nominal price compared to the total amount you have to pay under the agreement.
- The agreement designates part of the payments as interest, or that part is easy to recognize as interest.
Leveraged lease transactions may not be considered leases. Leveraged leases generally involve three parties: a lessor, a lessee, and a lender to the lessor. 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.
If you plan to take part in what appears to be a leveraged lease, you may want to get an advance ruling. 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. 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. Internal Revenue Bulletin 2001-19 is available at www.irs.gov/pub/irs-irbs/irb01-19.pdf.
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.
- 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.
- 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.
- The lessee may not invest in the property, except as provided by Revenue Procedure 2001-28.
- 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.
- The lessor must show that it expects to receive a profit apart from the tax deductions, allowances, credits, and other tax attributes.
The IRS may charge you a user fee for issuing a tax ruling. For more information, see Revenue Procedure 2009-1, on page 1 of Internal Revenue Bulletin No. 2009-1. Internal Revenue Bulletin 2009-1 is available at www.irs.gov/pub/irs-irbs/irb09-01.pdf
The IRS will not issue advance rulings on leveraged leases of so-called limited-use property. 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. See Revenue Procedure 2001-28 for examples of limited-use property and property that is not limited-use property. taxmap/pubs/p535-007.htm#en_us_publink1000243059
Special rules are provided for certain leases of tangible property. The rules apply if the lease calls for total payments of more than $250,000 and any of the following apply.
- Rents increase during the lease.
- Rents decrease during the lease.
- 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).
- 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).
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).
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. 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. For details, see section 467 of the Internal Revenue Code.