Section 179 Deductions for Non-Corporate Lessors

For asset protection purposes, business capital assets should normally be owned by a separate entity, as opposed to the business operating entity, and then leased back to the operating entity. A non-corporate leasing entity can still qualify for the favorable tax treatment of newly-purchased business assets under IRC § 179, which allows businesses to expense certain depreciable assets instead of depreciating them over a longer period of time. However, two additional requirements must be followed.

First, the term of the lease (including options to renew) must be less than 50 percent of the class life of the property. Second, for the 12 month period after the property is transferred to the lessee, the lessor's deductions attributable to the property (not including rents and reimbursed amounts) must exceed 15 percent of the rental income paid by the lessee.

In Ross P. Thomann v. Commissioner (TC Memo 2010-241), as discussed by Paul Bonner in the July 2011 Journal of Accountancy, the IRS disallowed a section 179 deduction for farm equipment primarily due to the lack of a written lease that clearly identified the property leased and the lease term. The taxpayer also presented no documentation of class life or a comparison of lease income with the lessor's deductions.

In order to avoid denial of the 179 deduction like the taxpayer in Thomann, documentation is the key. The lease agreement should clearly document each property being leased as well as the asset class life of each property so as to ensure that the term of the lease, taking into account options to renew, is less than half of the class life. Furthermore, the rent attributable to each property being leased should be documented, as well as the expenses, to ensure and demonstrate that deductions exceeding 15 percent of the rent income are taken by the lessor in the first 12 months. The lease agreement may need to specify that the lessor is responsible for expenses under the lease, and the lessor may need to frontload scheduled maintenance, insurance, etc. to ensure the 15 percent requirement is met.

By undertaking these steps, both asset protection and significant tax benefits can be realized.