Publication 535 |
2001 Tax Year |
Rent
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.
Unreasonable rent.
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 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. For examples of related persons, see
Related Persons in chapter 12.
Rent on your home.
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.
Rent paid in advance.
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.
Example 1.
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.
Example 2.
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 rent that
applies to that year.
Canceling a lease.
You generally can deduct as rent an amount you pay to cancel a
business lease.
Lease or purchase.
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.
Conditional sales contract.
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 leases.
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
in 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 in the same
Internal Revenue Bulletin provides the information required to be
furnished in a request for an advance ruling on a leveraged lease
transaction.
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 2002-1, in Internal
Revenue Bulletin No. 2002-1, or Publication 1375, which is a
reprint of Revenue Procedure 2002-1.
Leveraged leases of limited-use property.
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.
Leases over $250,000.
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 the regulations under section
467 of the Internal Revenue Code.
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