When you’re searching for a tenant to rent space in your building, you may have to sweeten the pot by offering concessions to the lessee — such as free or reduced rent and/or cash for moving expenses and fixing up the space so it fits your new tenant’s needs.
If you’re looking to rent space, especially for a business, lease concessions may be a negotiating tool used to get the best deal.
Of course, these incentives must be accounted for using accounting principles, and they all have tax consequences. Here’s how it works for landlords and tenants.
Lease inducements
In a nutshell, lease inducements are payments the landlord gives to the renter to make leasing a particular space more enticing.
Lease inducements can be made in the following forms:
- Cash.
- Free rent for X months.
- Transfer of ownership of land or a building.
- Reimbursement of costs incurred by the renter, including moving expenses.
Tax-wise, lease inducements are considered income for the renter and a cost for the landlord.
Allowances for upgrading up the space
Allowances that a landlord gives a renter to customize a space are generally treated as ordinary income by the tenant. It’s recorded when the renter receives the allowance, and it is depreciated over its useful life.
However, Section 110 of the U.S. tax code gives tenants a break if they structure the allowance wisely. Section 110 allows tenants to exclude the allowance from income if the money received isn’t more than the money paid to customize the space.
Also, the section specifies that the lease must be short-term — 15 years or less — and used as retail space, which is defined as space used for “selling tangible personal property or services to the general public.”
Here are two more tips regarding accounting for construction allowances:
- When writing the lease, landlords should include language that restricts the use of allowances for improvements to the interior of commercial property.
- Both the tenant and the landlord must disclose construction allowances on their federal tax returns.
Lease termination payments
Sometimes a landlord needs a tenant to vacate the property before the end of the lease; sometimes, the tenant wants out sooner than anyone expected.
Both scenarios may include payments and tax consequences. For instance, if a landlord pays a tenant to vacate, he or she can deduct the payments over the remaining term of the terminated lease. If the landlord receives payments from the tenant, he or she must treat the payments as taxable income in lieu of rent.
This is just the beginning of a complex situation. Concessions to the lessee can have unexpected tax consequences, so be sure to consult a tax professional if you have questions. Wondering if Stambaugh can help you with your tax problems? View our service area to see if you live within the cities and counties we serve.
