Rent as a Business Expense

Many businesses pay rent for the use of property. In general, a taxpayer can deduct rent paid as an expense only if the property rented is used in the business and the taxpayer does not have nor will he receive equity in or title to the property.

Not All Rent Paid for the Use of Property in a Business in Deductible

Unreasonable Rent. The issue of the reasonableness of rent only usually comes up when the taxpayer seeking a rent expense deduction and he and the lessor are related. In general, the test for the reasonableness of rent is the arm's length test: would the taxpayer have paid the same amount to an unrelated party? If the answer is yes, the rent is probably not unreasonable. Rent expense that is calculated as a percentage of sales in not generally considered unreasonable.

Advanced Payments of Rent. Usually, a taxpayer renting property is only allowed to deduct the amount of rent that applies to the use of the property during the tax year. The remainder of the advanced payment is deductible in the future years when the property will be used.

Lease or Purchase? Sometimes an arrangement that is called a lease is not really a rental transaction at all, but is in reality a conditional sales contract. The distinction is important because payments made under a conditional sales contract are not deductible as rent expense.

In determining whether the arrangement is a genuine lease or a conditional sales contract, the intent of the parties must be examined. Some facts pointing to a conditional sales contract include the following: an application of a portion of each payment to a growing equity interest in the property; the transfer of title to the taxpayer at the end of the required payments; payments that are much more than the fair market value of the property; an option to purchase the property at the end of the period at a nominal price; or a portion of the each payment is easily recognizable as interest.

If the transaction is considered a leveraged lease, the payments may not be deductible as rent expense. In general, a leveraged lease involves three parties: a lessor, a lender to the lessor, and a lessee. Payments in a leveraged lease arrangement usually cover most 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 his lender. In order to determine whether payments made under the specific facts of any leveraged lease arrangement are deductible, it is prudent to get an advanced ruling by the Internal Revenue Service.

Rent Paid on a Taxpayer's Home. Rent paid on a home that is partially used for business is usually deductible based on the proportion of the space used for business.

Certain Leases of Tangible Personal Property. Different rules apply if the total payments made over the lifetime of a lease of tangible property exceed $250,000 and the rents change during the lease are deferred or are prepaid. Under those circumstances, the taxpayer is required to calculate the amount of deductible rent expense by using the accrual method of accounting and principles of the time value of money. If the IRS determines that the lease was structured with improper tax avoidance in mind, interest will be imputed into the arrangement.

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