Rent

Rent is any amount you pay for the use of property that you do not own. In general, you can deduct rent as an expense only if the rent is for property that 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 rents that are unreasonable. Ordinarily, the issue of reasonableness of the rent will not arise unless you and the lessor are related. Rent paid to a related party is reasonable if it is the same amount you would pay to a stranger for use of the same property. A percentage rental is reasonable if the rental paid is reasonable. For a definition of related taxpayers, see chapter 2.

Rent on your home. If you rent rather than own a home and use part of your home 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 Qualifying for a Deduction in Publication 587.

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. In May you leased a building for 5 years beginning July 1 and ending June 30 five years later. According to the terms of the lease, 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. You can deduct the rest ($12,000) over the remaining 2-year term of the lease at $6,000 each year.

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. If, under the agreement, you acquired or will acquire title to or equity in the property, you should treat the agreement as a conditional sales contract. Payments made under a conditional sales contract are not deductible as rent expense.

Whether the agreement is a conditional sales contract depends on the intent of the parties. Determine intent based on the facts and circumstances that exist when you make the agreement.

Determining the intent. In general, an agreement may be considered a conditional sales contract rather than a lease if any of the following is true:

òThe agreement applies part of each payment toward an equity interest that you will receive. òYou get title to the property upon the payment of a stated amount required under the contract. òThe amount you 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. òYou pay much more than the current fair rental value for the property. òYou have an option to buy the property at a nominal price compared to the value of the property when you may take advantage of the option. Determine this value when you make the agreement. òYou have an option to buy the property at a nominal price compared to the total amount you have to pay under the lease. òThe lease designates some part of the payments as interest, or part of the payments are easy to recognize as interest.