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Collect tax-favored rent from your company

by on
in Small Business Tax,Small Business Tax Deduction Strategies

You own equipment, furniture and other assets that your business could put to good use. You could sell those assets to your business, but that might drain your company's cash reserves. Plus, the sale proceeds would be taxable to you personally.

Strategy: Lease those assets to your C corporation business, instead. By doing that, your company can write off the lease payments as ordinary and necessary business expenses. The rent is taxable to you, but you can shelter it using deductions such as depreciation and repairs.

This is a great method for pulling tax-free cash out of your C corp. Unlike wages, the rent payments aren't subject to employment taxes.

Even better: As a new case shows, you may be able to claim a tax loss on the deal if you handle your rental activities like a business. (Misko, TC Memo 2005-166)

Tax Court case: Mr. Misko ran his law practice as a C corporation. He began leasing about $1.8 million of his personally owned computers, furniture and audiovisual equipment to his law firm.

Misko intended to receive rent payments roughly equivalent to the equipment's annual depreciation deductions. Over a six-year period, he received rental payments from the law firm totaling $1.04 million. During that same time, Misko claimed depreciation deductions on the equipment he leased.

In two of those tax years, the law firm reported no income and was unable to pay rent, generating a loss from the leasing activities. Ultimately, the leasing activity didn't prove to be profitable, primarily because of the losses in the two years at issue. Misko eventually sold the equipment to the law firm at its book value of approximately $550,000.

Point of contention: The IRS argued that the losses were "hobby losses" that could not be deducted in excess of income from the leasing activity. So, it denied the losses claimed in those two tax years.

Misko objected, and the Tax Court agreed with him. Reason: Misko followed his tax pro's advice in setting up the arrangement. He used the equipment exclusively for his practice, he had a high degree of knowledge about the equipment and he collected rent consistently (except for the two years at issue). The leasing deal was a bona fide business transaction.


Similarly, Misko was able to dodge the passive activity loss restrictions because he "materially participated" in the rental activity. Result: He could write off the full amount of the losses the lease generated.


Bottom line: Don't get greedy. Charge your company a reasonable rent. Otherwise, the IRS may claim that the rental payments are disguised dividends. You may want to obtain an independent appraisal of fair rental value.

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