How JustAnswer Works:

  • Ask an Expert
    Experts are full of valuable knowledge and are ready to help with any question. Credentials confirmed by a Fortune 500 verification firm.
  • Get a Professional Answer
    Via email, text message, or notification as you wait on our site.
    Ask follow up questions if you need to.
  • 100% Satisfaction Guarantee
    Rate the answer you receive.

Ask PDtax Your Own Question

PDtax
PDtax, CPA firm owner
Category: Tax
Satisfied Customers: 1746
Experience:  32 years tax experience, including four years at a Big 4 firm.
Type Your Tax Question Here...
PDtax is online now
A new question is answered every 9 seconds

This is for PD Tax. The following is how I answered the

Resolved Question:

This is for PD Tax.

The following is how I answered the question I posed to you. I had to submit today. Please review and let me know if I need to make corrections after the fact. Thanks.

For the tenant’s treatment of rental payments and additional lease expenses, Windish (2008) indicates "rent is the payment by the user of property [tenant] to the owner of property [landlord] for its use and enjoyment. In general, gross income includes rentals received or accrued for the occupancy of real estate. Rentals or other payments, required to be made as a condition to the continued use or possession, for purposes of the trade or business, of property to which the taxpayer [tenant] has not taken title or in which the taxpayer [tenant] has no equity, are deductible as ordinary and necessary business expenses" (p 126).

For the landlord's treatment of additional lease expenses, Windish (2008) indicates that "rent may be paid indirectly, for example, through the payment of the lessor's expenses or debts by the lessee. If the payment is made as a condition to the use or occupancy of property, other than as a payment toward the purchase of the property, the payment, regardless of its form, is rent" (p 126).

Using net leases definitely provides opportunities to minimize taxes for the tenant. Specifically, any improvements made by the lessee in a short-term nonresidential lease for a trade or business may be depreciated in a shorter period of time rather than their normal class life. In fact, it is my understanding that the tenant's improvements are depreciated within the length of the lease. For example, let's say a tenant leases space in a newly built nonresidential rental property to open a coffee shop. The space does not have air conditioning so the tenant installs a central air conditioning system. Normally, the expense for structural components such as air conditioning must be capitalized and depreciated for 39 years which is the class life of a nonresidential rental property. However, since the tenant has a 10-year lease, the air conditioning system would be depreciated within the 10 years, assuming the tenant intends to terminate the lease in the 10th year. I think the depreciation amount for the first nine years of the lease would be the same as if the recovery period was 39 years. However, in the 10th year, the tenant would recover the remaining depreciation.

Although I cannot think of a really good example how a net lease can minimize taxes for a landlord, I believe it can. Most likely, it would have something to do with the way the net lease is written. I do know the rental payments for net leases are generally lower than most of the other types. Therefore, lower income for the landlord means fewer taxes. If I think of something better, I will add it to this post. On the other hand, one big advantage of a net lease to the landlord is that the amount of money the landlord saves by allowing the tenant(s) to make improvements to the rental property allows him or her to have more money to invest in other money-making endeavors.

Resources:

Windish, D. E. (2008). Practical Guide to Real Estate Taxation. Chicago, Illinois: CCH, a Wolters Kluwer business.
The Tax Book (2012).
Submitted: 9 months ago.
Category: Tax
Expert:  PDtax replied 9 months ago.

PDtax :

Hi again. To Q & A for more...

Expert:  PDtax replied 9 months ago.
Our chat has ended, but you can still continue to ask me questions here until you are satisfied with your answer. Come back to this page to view our conversation and any other new information.

What happens now?

If you haven’t already done so, please rate your answer above. Or, you can reply to me using the box below.
Expert:  PDtax replied 9 months ago.
I started our review of net leases with a review of the business model. Net leases have evolved into investment vehicles for absentee landlords. They are priced so to yield a predictable, steady yield. The contracts take much of the 'business' out of the business of renting commercial property.

The tenant can be charged (in theory) a lower per sq. ft. rate, but is then at risk for some or potentially all the costs of upkeep, maintenance, their share of taxes, utilities, etc. Since that's the common portrayal of the agreements, let's look at the operation.

Tenant agrees to lease space, and needs HVAC. HVAC equipment is indeed Section 1250 property, as supported by a cost segregation assembly put together by IRS (http://www.irs.gov/Businesses/Cost-Segregation-ATG---Chapter-6.4-Relevant-Court-Cases). The court cases listed are noteworthy for their items added to buildings, and the 1245 or 1250 treatment determined by litigation.

I think we can further agree that Section 179 property must be 1245 property, so HVAC equipment, or the roof in your prior example, would not be eligible for accelerated depreciation. Things like glass storefronts, floor coverings, etc., are.

I agree that the 1250 property paid for by the tenant must be treated as 1250 property, depreciated over its useful life, with an adjustment at lease termination for unused depreciation (when the tenant vacates).

I also agree that under the extreme model we are using, that landlords are using the net lease model to put responsibility onto the tenant. At this extreme, it is hard to see what involvement a landlord would even have. Even if the landlord builds out for the tenant and includes some 1245 property, the landlord does not have an accelerated tax advantage in the build out.

One example of a landlord's tax advantages can come from accruals they can establish for things like end of lease remodeling/rehab we discussed earlier. The model does allow for a known history of these accruals, so some deduction acceleration is available. That Dollar store example is useful here. The life of the store as a store is generally ten years with renewal options, but the stores are located in lower income areas. Their second use is often as an auto body shop, which might require significant revisions for access and egress, utility usage, shop doors, interior build out for office/waiting areas, etc. I believe those costs can be accrued before the lease term ends, which would give a landlord a tax advantage based on the terms of a net lease.

Otherwise, I think your answer covers the subject. Thanks again from Just Answer and me, PDtax.
Customer: replied 9 months ago.
Believe it not, I will be teaching the Advanced Rental Income course for my employer next week and I am struggling over this.

Thanks for the review. In all honesty, I do not understand the example you provided about the Dollar store. (By the way, not all dollar stores are located in lower income areas.)

I think I am having problems with this because of my personal experience with net leases.

Currently, I do the bookkeeping for an investor who leases all of his properties using net leases. The investor does nothing for his tenants except provide the rental properties. He does not perform any end of lease remodeling. In fact, he does nothing to accommodate the tenants. However, if the roof needed to be replaced or there were major plumbing problems which would interfere with leasing the property, he would take care of them. Otherwise, the tenants lease the property "as is". Therefore, I guess my examples would be somewhat "extreme".

First of all, am I correct in thinking that a net lease can be used for a residential rental property?

Next, I believe you are saying that not all net leases have to be so extreme. The landlord may accommodate the tenant in some things and yet require the tenant to be responsible for some of the landlord's expenses. What I do not understand is the accruals you referenced. Do you mean things like carpeting or temporary walls? Please explain.




Customer: replied 9 months ago.
One more thing. Are the following statements correct? I can accept the following as true if the invoices were for water, air conditioning maintenance, pest control, or landscaping, but can a tenant pay the real estate taxes and claim the payment as such?

"Where you have a single property being rented by a tenant, the bills can go directly to the tenant to pay. In this case the tenant would expense each bill as it is paid according to the type of expense like property taxes and show it as a separate line item."

Expert:  PDtax replied 9 months ago.

Thanks for the review. In all honesty, I do not understand the example you provided about the Dollar store. (By the way, not all dollar stores are located in lower income areas.) The model for one of the store chains is for investors to do buildout of property, and ten year boiler plate leases are provided as a base for negotiations. The problem for investors comes at the end of the first ten years, when the economics of the area don't support the store, so it leaves, and the investor is left with twenty years to service a mortgage and needs to re-rent.

Currently, I do the bookkeeping for an investor who leases all of his properties using net leases. The investor does nothing for his tenants except provide the rental properties. He does not perform any end of lease remodeling. In fact, he does nothing to accommodate the tenants. However, if the roof needed to be replaced or there were major plumbing problems which would interfere with leasing the property, he would take care of them. Otherwise, the tenants lease the property "as is". Therefore, I guess my examples would be somewhat "extreme". I agree. The roof thing would be a tough one to have to take on as a tenant.

First of all, am I correct in thinking that a net lease can be used for a residential rental property? Yes, and it's often done that way informally. People renting homes are often responsible for cutting grass, taking out trash, and I have seen residential leases that required things like payment of rent to the bank for the mortgage, requirement that liability insurance be obtained by tenant, etc.

Next, I believe you are saying that not all net leases have to be so extreme. The landlord may accommodate the tenant in some things and yet require the tenant to be responsible for some of the landlord's expenses. What I do not understand is the accruals you referenced. Do you mean things like carpeting or temporary walls? Please explain. Yes, I do. These assets with a depreciable life less than the lease life could be depreciable faster than the rent, so a tax advantage can be obtained.

 

Now, to part 2:

 

Since they are part of the rental cost, they will have to be deductible. The real question is classification. I would claim them just as additional rent (let's say the rent was $1,500, and property taxes were $340, and CAM an extra $55, I could lump it all to rent for $1,895. Easiest, cleanest. And, it wakes a client up when they see just how much the net lease costs them. Or, split it out and call the other items 'share of property taxes as part of lease' or other such label. Just don't call it property taxes, since you can't claim property taxes as a deduction for property you don't own. Thanks again. PDtax

Customer: replied 9 months ago.
Lastly, do the accruals depreciate more quickly than their class life? In other words, if the landlord replaces the carpet for a tenant and the tenant leaves after three years and landlord replaces the carpet for the next tenant, can the landlord recover the remaining depreciation on the carpet he replaced for the first tenant within the three years? I hope my question makes sense.
Customer: replied 9 months ago.
Another student is disputing my statement about the shorter depreciation period, such as the duration of the lease, for improvements made by tenants. The following is her response. My argument here is that at the end of the lease, the tenant is irrevocably abandoning the improvement. Is that correct?

From what I understand, the leasehold improvements are depreciated over 39 years for both the lessee and the lessor.

The 1993 Revenue Reconciliation Act requires all leasehold improvements, whether owned by the lessor or the lessee, be depreciated via MACRS which currently prescribes a recovery period of 39 years for commercial real estate. Lessor arguments to write off improvements over much shorter lease terms are now foreclosed since MACRS rules provide no special exception for property built for a lessee. IRC Sec. 168(I)(6) explicitly indicates that for all additions and improvements to property, the same recovery period applies as would apply to the underlying property.

The landlord and the tenant can deduct the remaining basis, if in fact the improvements are irrevocably abandoned or disposed of.

http://www.irs.gov/irb/2012-14_IRB/ar05.html

Expert:  PDtax replied 9 months ago.
If you add five year assets into a property with a seven year lease term remaining, your depreciation will come faster than the rent. That's what I meant by accruals.

If you add ten year property to a lease with seven years left, the property will have three years depreciation available at lease term end. The tenant who paid for the improvements gets to depreciate them at lease termination. The landlord gets an asset with tax basis of $0. He might have to remove the items, and dispose of them at his cost.

I believe your argument is correct, and that no basis or value passes to the landlord.

Thanks again.

PDtax

Customer: replied 9 months ago.
Here we go again. I wish I could make an appointment with you so that I could ask all of the questions that arise from the original question posed.

By the way, I had eye surgery today. Hopefully, my spelling is correct because I cannot see too well.

Anyway, let's discuss leasehold improvements made by the tenant. If the leasehold improvement is a structural component which would normally be capitalized for 39 years for a nonresidential rental property, when the lease ends in a 10-year lease, does the tenant get to recover the remaining 29 years of depreciation based on the latest IRS changes in the law?
Expert:  PDtax replied 9 months ago.
http://www.irs.gov/irb/2012-14_IRB/ar05.html#d0e722 is the link to the IRS information contained below.

b. Operative rules for leasehold improvements

The IRS and the Treasury Department received several comments requesting that the regulations provide guidance regarding the application of the improvement rules to leased section 1250 property (generally real property) and leased section 1245 property (generally personal property). The temporary regulations apply to both leased real property and leased personal property and provide operative rules for both lessees and lessors that make improvements to a leased unit of property.
i. Lessee improvements

Under the temporary regulations, a taxpayer lessee must capitalize the aggregate of related amounts that it pays to improve a unit of leased property, except to the extent that section 110 applies to a construction allowance received by the lessee for the purpose of such improvement or where the improvement constitutes a substitute for rent. A taxpayer lessee must also capitalize the aggregate of related amounts paid by the lessor to improve a unit of leased property if the lessee owns the improvement for federal income tax purposes, except to the extent that section 110 applies to a construction allowance received by the lessee for the purpose of such improvement. An amount paid for a lessee improvement under the temporary regulations is treated as an amount paid to acquire or produce a unit of real or personal property under §1.263(a)-2T(d)(1)(i).

Because a lessee improvement involves the acquisition or production of a new and distinct interest in property and this property interest is often different from the underlying leased property, amounts paid for a lessee improvement are treated as the acquisition or production of a new unit of property (that is, a unit of property separate from the leased unit of property), rather than an improvement to the underlying property. This treatment is consistent with the depreciation requirements under section 168(i)(8)(A), which do not allow a taxpayer to depreciate leasehold improvements over the term of the underlying lease, but rather require that a taxpayer depreciate the leasehold improvement over the applicable recovery period under MACRS for the type of property acquired or produced.

Expert again...So we agree that the property added by the tenant as part of their net lease is likely a depreciable asset in the lessee's hands, to be depreciated. This assumes things like the rent is not artificially low, and the improvements are really received in lieu of rent.

Also by IRS, at http://www.irs.gov/publications/p535/ch03.html#en_US_2012_publink1000243073:

Improvements by Lessee

If you add buildings or make other permanent improvements to leased property, depreciate the cost of the improvements using the modified accelerated cost recovery system (MACRS). Depreciate the property over its appropriate recovery period. You cannot amortize the cost over the remaining term of the lease.

If you do not keep the improvements when you end the lease, figure your gain or loss based on your adjusted basis in the improvements at that time.

Expert again...There is a loss on sale at lease end to be recognized by lessee. Report it as a loss on 4797.

The tenant does get the benefit of the amount spent, as a loss on sale in the year the lease ends.

Thanks again from Just Answer and PDtax.
PDtax, CPA firm owner
Category: Tax
Satisfied Customers: 1746
Experience: 32 years tax experience, including four years at a Big 4 firm.
PDtax and 2 other Tax Specialists are ready to help you
Customer: replied 9 months ago.
Thank you very much for your thorough answer. I truly appreciate it.
Expert:  PDtax replied 9 months ago.
you're welcome. it seems like we always have to go to the treatises, or regs, or pubs, but we get there.

PDtax
Customer: replied 9 months ago.
Yes, this is true. I need to find a course on how to do tax research. I really do try. However, I never really seem to be able to get where I need to be. I read one law and it refers me to another law or to a case. Therefore, I am constantly reading a lot of legalese which is not relevant. I am going to see if the university has such a course.

Thanks again for your all of your help.

JustAnswer in the News:

 
 
 
Ask-a-doc Web sites: If you've got a quick question, you can try to get an answer from sites that say they have various specialists on hand to give quick answers... Justanswer.com.
JustAnswer.com...has seen a spike since October in legal questions from readers about layoffs, unemployment and severance.
Web sites like justanswer.com/legal
...leave nothing to chance.
Traffic on JustAnswer rose 14 percent...and had nearly 400,000 page views in 30 days...inquiries related to stress, high blood pressure, drinking and heart pain jumped 33 percent.
Tory Johnson, GMA Workplace Contributor, discusses work-from-home jobs, such as JustAnswer in which verified Experts answer people’s questions.
I will tell you that...the things you have to go through to be an Expert are quite rigorous.
 
 
 

What Customers are Saying:

 
 
 
  • I really was impressed with the prompt response. Your expert was not only a tax expert, but a people expert!!! Her genuine and caring attitude came across in her response... T.G.W Matteson, IL
< Last | Next >
  • I really was impressed with the prompt response. Your expert was not only a tax expert, but a people expert!!! Her genuine and caring attitude came across in her response... T.G.W Matteson, IL
  • I WON!!! I just wanted you to know that your original answer gave me the courage and confidence to go into yesterday's audit ready to fight. Bonnie Chesnee, SC
  • Great service. Answered my complex tax question in detail and provided a lot of additional useful information for my specific situation. John Minneapolis, MN
  • Excellent information, very quick reply. The experts really take the time to address your questions, it is well worth the fee, for the peace of mind they can provide you with. Orville Hesperia, California
  • Wonderful service, prompt, efficient, and accurate. Couldn't have asked for more. I cannot thank you enough for your help. Mary C. Freshfield, Liverpool, UK
  • This expert is wonderful. They truly know what they are talking about, and they actually care about you. They really helped put my nerves at ease. Thank you so much!!!! Alex Los Angeles, CA
  • Thank you for all your help. It is nice to know that this service is here for people like myself, who need answers fast and are not sure who to consult. GP Hesperia, CA
 
 
 

Meet The Experts:

 
 
 
  • Wallstreet Esq.'s Avatar

    Wallstreet Esq.

    Tax Attorney

    Satisfied Customers:

    566
    10 years experience
< Last | Next >
  • http://ww2.justanswer.com/uploads/KU/KUMI95/2013-9-30_195031_kumar.64x64.jpg Wallstreet Esq.'s Avatar

    Wallstreet Esq.

    Tax Attorney

    Satisfied Customers:

    566
    10 years experience
  • http://ww2.justanswer.com/uploads/CU/Cuttinggirl/2011-10-29_03719_wcrop2.64x64.jpg Wendy Reed's Avatar

    Wendy Reed

    Enrolled Agent

    Satisfied Customers:

    3046
    10+ years tax preparation and tax advice.
  • http://ww2.justanswer.com/uploads/CATax/2009-08-04_204548_Mark.jpg Mark D's Avatar

    Mark D

    Enrolled Agent

    Satisfied Customers:

    985
    MBA, EA, Specializing in Business and Individual Tax Returns and Issues
  • http://ww2.justanswer.com/uploads/IN/insearchoftheanswer/2013-8-16_0233_attorney.64x64.jpg Richard's Avatar

    Richard

    Tax Attorney

    Satisfied Customers:

    3103
    29 years of experience as a tax, real estate, and business attorney.
  • http://ww2.justanswer.com/uploads/MY/MyVirtualCPA/2012-7-5_44024_cookmegan1.64x64.jpg Megan C's Avatar

    Megan C

    CPA, CMA, CFE

    Satisfied Customers:

    3257
    Licensed CPA, CFE, CMA who teaches accounting courses at Master's Level
  • http://ww2.justanswer.com/uploads/JG/jgordosea/2012-6-7_43138_GordosVeritas.64x64.jpg jgordosea's Avatar

    jgordosea

    Enrolled Agent

    Satisfied Customers:

    2679
    I've prepared all types of taxes since 1987.
  • http://ww2.justanswer.com/uploads/OZ/ozaukeecpa/2012-6-7_193219_Picture1croppedandshrunk.64x64.jpg MequonCPA's Avatar

    MequonCPA

    Certified Public Accountant (CPA)

    Satisfied Customers:

    2219
    CPA, Over 30 yrs experience w/individuals and small businesses. Masters in Tax.