Leasing property to your C corporation is an effective way to withdraw money from the corporation without incurring additional payroll taxes. A corporation can pay rent to a shareholder for use of the shareholder’s property. The corporation takes a tax deduction for rent paid, and the shareholder reports rental income on his or her personal return. Distributions in the form of rent will not only help avoid the double tax on dividend distributions from a C corporation, but can also help avoid payroll taxes on wage payments.
As with the other distribution methods, the IRS will reclassify the rent as a dividend when payments are unreasonable. If your company is not a C corporation, then there is no issue regarding double taxation of dividend distributions. You can still lease property to your company, but you will not receive the tax benefits available to owners of C corporations.
Tip: It is usually advisable to have an independent appraiser set the rental rate. It doesn’t guarantee that the IRS won’t scrutinize the transaction, but it gives the company a basis on which to sustain its rental deductions.
When Can You Use It?
You can rent property to your business when you own real estate or personal property that your business can use. If you own a C corporation and want to take advantages of certain tax benefits, then the transaction should be treated as an arm’s length transaction and should have a valid business purpose.
Benefits of Renting Property to Your Business
Avoid Double Taxation of Dividends
Corporate earnings are taxed first as income to the C corporation, then again as they are distributed as dividends to the recipient. If you receive money in the form of rent rather than distributions, then the company can take a deduction for the rental expenses. The rent payments are only taxed once, as income to you.
Tip: Several pieces of legislation provide that dividends received by an individual shareholder from domestic corporations (and qualified foreign corporations) are taxed at long-term capital gains tax rates for taxable years beginning in 2003 through 2012. For tax years prior to January 1, 2003, dividends were taxed as ordinary income. Absent further legislative action, dividends will be taxed again as ordinary income beginning in 2013.
Example(s): Assume Hal owns a C corporation. The corporation earmarks $100,000 of revenues for distributions to Hal as dividends. Before the company can make a distribution, it must pay a corporate income tax at a rate of 25 percent. That leaves $75,000 available for distribution to Hal as dividends. When Hal receives the money, he is taxed at a capital gains rate of 15 percent. Out of the original $100,000 of revenues, Hal takes home $63,750.
Assume Dick also owns a C corporation. He rents a building to his company, and the company earmarks $100,000 of revenues for annual rental payments. The company is allowed to take a deduction for the rental payments (assuming that they represent a market value rental payment). Accordingly, the entire $100,000 is paid out to Dick as landlord. When Dick receives the money, he is taxed at an ordinary income tax rate of 35 percent. Out of the original $100,000 of revenues, Dick takes home $65,000, $1,250 more than Hal.
Transfer Property to Family Members to Shift Income Tax to Lower Bracket
You can gift directly, or by way of a trust, property to your children, spouse, or other family members. In turn, they can lease the property to your company. If they are in a lower tax bracket than you are, they will be taxed at a lower rate on the rental income they receive. This may lower your family’s combined tax liability.
Tradeoffs of Renting Property to Your Business
Tax Code Restricts Certain Home Expenses
If you rent a portion of your home to your business, you may not claim a deduction for home expenses that are attributable to the rental of the residence to the business during any period of time in which you use the residence as an employee of the business.
Rental Income Can Become Subject to Self-Employment Tax
Income received from the rental of personal property (such as vehicles or equipment) is subject to self-employment tax if the activity is conducted as a business. The IRS examines a number of factors when determining whether rental activity constitutes a trade or business, including the following:
• The taxpayer’s profit motive
• The amount of time devoted by the taxpayer to the activity
• Whether the activity is conducted on a regular, ongoing basis
If you have questions or need assistance, contact the Business Experts at Henssler Financial:experts@henssler.com or 770-429-9166.