United States

Leasing your office or building? Be mindful of this tax pitfall

TAX BLOG  | 

If you lease office space or buildings, you may take advantage of lease agreements that contain free rent periods or increasing rent payments over time.

Under generally accepted accounting principles, the total value of the lease payments is aggregated and divided over the term of the lease, commonly referred to as straight-line rent recognition.

While this is an acceptable method of recognizing rent expense for financial statement purposes, under federal tax law, taxpayers must generally follow the terms of the lease in recognizing rent expense (e.g., deduct what is actually due in each year under the lease provisions). Failure to follow this method for tax purposes could create a mismatch in the timing of recognizing rent expense (expensing more rent than allowed in the early periods of the lease), leaving the door open for the IRS to assess penalties and interest upon exam.

Fortunately, businesses can generally file an application for a change in accounting method related to lease payments to change from following book treatment to adopting the proper tax treatment. If you are not currently following a proper tax method, consult your tax advisors to determine your eligibility to file this tax accounting method change to avoid exposure to IRS exam adjustments.


Christian Wood

Principal

Christian leads the technical research and analysis for RSM’s accounting methods and periods team nationally. Contact him at christian.wood@rsmus.com.

Areas of focus: Accounting Methods and PeriodsTangible Property Tax Consulting Washington National Tax