 Income tax 2022-2023, business expenses, rent expense. Let's do some wealth preservation with some tax preparation. Support accounting instruction by clicking the link below, giving you a free month membership to all of the content on our website, broken out by category, further broken out by course. Each course then organized in a logical, reasonable fashion, making it much more easy to find what you need then can be done on a YouTube page. We also include added resources such as Excel practice problems, PDF files and more like QuickBooks backup files when applicable. So once again, click the link below for a free month membership to our website and all the content on it. Most of this information comes from the Tax Guide for Small Business for Individuals Who Use Schedule C, Publication 334 Tax Year 2022, you can find on the IRS website, irs.gov, irs.gov. Looking at the income tax formula, we're focused on line one income. Remember in the first half of the income tax formula is in essence an income statement, but just an outline. Other forms and schedules flowing into these line items, one of those, the Schedule C. Having business income minus business expenses, the net business income from the Schedule C flowing into line one income of the income tax formula. When we look at page one of the Form 1040, note that the Schedule 1 is what the Schedule C flows into and then it flows from there into page one of Form 1040, line number eight. The Schedule C is a profit or loss from business. Having an income statement format, income minus expenses, we're focused here on the expense side of things and specifically on the rent expense side of things. All right, so rent expense. So when we think about rent expense, just remember we're not thinking generally personal rent. We're thinking the business rent's got to be ordinary and necessary for the business. You might be asking and thinking, well, hey, I do my business in my home. Well, then you have a home office type of situation and you might be renting the home or you might be owning the home. If you rent the home, then yes, some of that rent might be business related in a home office kind of system. Okay. So let's get into it. Rent is any amount you pay for the use of property you do not own. So we know what rent is. It's not our stuff. We're renting it. We're just using it. We're paying for the use of it. So in general, you can deduct rent as a business expense only if the rent is for property you use in your business. So if you use whatever office building in your business or if you're renting equipment or something like that similar type of situation, then it would be a business expense you would think and you would be expensing it when you make the rent payments usually. So if you have or will receive equity in or title to the property, you cannot deduct the rent. So this is where it gets messy because if you imagine buying a piece of equipment, for example, then if you were to buy the equipment and finance the equipment, that's different than say renting the equipment. And a lot of people get this confused. And I think one of the reasons is because of the main thing that we purchase, the big thing we purchase as a home on the personal side of things. And we're so used to people saying, well, I don't really own the home. The bank owns the home. And they're referring to the fact that the bank has has a loan that's secured that's secured by the home. And it's used to I think that's a joke, right? It's used to be a joke. Well, the bank owns, you know, 80% of my home, but they don't really own 80% of the home. They have a loan. You owe the bank and the loan is collateral. They only have access to the to the home if you default on the loan. And the way to realize that is obviously the bank can't come to the kitchen table and have a discussion and say I own 80%. And therefore we need new rugs in the in the living room or something, you know, we need to redo the kitchen. They don't get to vote on that kind of stuff. So renting is is different than financing. So if we apply that to like a piece of equipment, then then if we if we finance the piece of equipment, then we've got the loan that we have to put on the books to deal with. We're going to be paying interest on the loan, which is kind of like a rent on the purchasing power in order to buy the equipment. The equipment will be on the books as an asset because we couldn't expense it most likely because it's a big piece of equipment we're going to use into the future. And then we expense it in the form of depreciation, possibly being able to have the 179 deduction or and or the special deduction to allow us to expense a lot or all of it upfront. If we rent it on the other hand, then you can imagine we have a piece of equipment that we are we're going to be paying rental. Now, because we don't actually own it, we're not going to be able to put it on the books and depreciate it. But instead, we're going to be paying for it and expensing it when we make the rental payments. Usually you're going to, as you use the property, you make the rental payments and you would be expensing it in the end when you make the rental payments. Now, these days, you would think those two methods would come out somewhat kind of similar in that, like when you buy the property, they you usually allocate the depreciation over the useful life. So you get the depreciation over the useful life. But these days, you get that massive 179 and special depreciation. So if you buy it, then that could be a benefit to the purchaser of over renting. If you get that massive deduction upfront, whereas if you rent it, then you're not going to get that massive deduction upfront. If it's a normal rent, you're going to be getting the deduction when you pay for the property because you don't actually own the property. Now, it's possible to try to set up a situation that's structured in form as though it's a rental agreement, but in actuality, it's a purchase. So for example, if you said, if they set up an agreement that basically said that you're going to rent it for the life of the equipment, or that you're going to be able to purchase it for $1 at the end of the rental agreement, or you're required to rent it for so long that it'll actually account for like the whole purchase price of the equipment, then in format, you've actually bought it and you set it up as a rental agreement for whatever reason, possibly tax reasons on either the seller or purchaser side that preferred it to be formatted as a renting agreement as opposed to a purchase kind of system. So then we get into these issues where, well, was it really a purchase, even though it looks like a rental thing, and do I have to treat it as a purchase or a rental thing? Okay, so unreasonable rent. So you cannot take a rental deduction for unreasonable rents. Ordinarily, the issue of reasonableness arises only if you and the lease are related. So if you have a market transaction, which we might call like an arms length transaction to people that have opposing interests in the transaction, usually the person that's renting the property wants to have as low a rent as possible. And the person that is the rentor wants to sell it or rent it for as high as possible. But if you have related parties, then everything goes out the window because if a father is renting to a son or something like that, they can start to manipulate or try to manipulate between the payments in order to maximize, say, tax benefits or something like that. So whenever you have a related party transaction, you get into these rules of, well, these types of transactions need to be reasonable, whatever that is, which, you know, what it would be for a market transaction. It's hard to tell because it's not a market transaction because you have related people in it. But rent paid to a related person is reasonable. If it is the same amount, you would pay to a stranger for use of the same property. Rent is not unreasonable just because it is figured as a percentage of gross receipts. Related persons include members of your immediate family, including siblings, either whole or half, your spouse, ancestors and lineal descendants for a list of the other related persons. See section 267 of the internal revenue code, rent on your home. If you rent your home and use part of it as your place of business, you may be able to deduct the rent you pay for that part. So if you, so this is the home kind of issues. You can't, when you're talking about your home, if you own the home, if it's a house you own, then you may be able to get the interest deduction, which is a big deduction and property taxes on the schedule A. And we talked and so that's a whole nother kind of thing. Those deductions lead people to kind of be confused about the nature of normal deductions for an income tax system, because you would think in an income tax system, the deductions that would be applicable that you can take are those that you needed in order to generate revenue. So if it's a personal deduction, you would think normally they wouldn't be deductible unless there's some other rationale for the law to do that. In this case, though, you're saying if you use the home for your business, then you might either rent the home or own the home. If you own the home, then you have interest that you're paying and you have the property taxes, which you might be able to allocate to your to your business, part of them and part of them to schedule A. So then you've got the splitting thing. And then if you rent the home, then you get you might be able to get a benefit from the part from the rent from part of the rent, which could be huge, of course. So and that would be coming to the business use of the home. So you must meet the requirements for business use of the home. So it's a whole nother topic in and of itself that you can dive into for the business use of the home. But the general idea is that you have to have some part that's going to be laid out for your particular business and possibly you can use a ratio type of analysis of the square foot of your business part versus everything else. And you can't just have some non business place that you do some business in. It's got to be, you know, usually strictly related to business. So if you do if you do some work, sometimes on your laptop in bed, you can't you can't deduct the square footage of your bed ratio rent deduction because presumably you do personal stuff like sleep in there too, which isn't business related. So so for more, so for more information on that, you could see business use of your home later. OK, rent paid in advance. And now we're getting some funny business on the rent because note that you might be on an accrual system or you might be on a cashed base system. If you're on a cashed based system, then normally you take the deduction when the cash is paid, but you can start to manipulate a cashed based system by saying, hey, look, if I think I made more money this year, then next year I'm going to make a deal with my landlord that I have that I pay my business rent to for my office building and say, look, I want to pay you all of my rent for the next three years on December 31st so I can deduct it all this year because my income was substantially higher this year for whatever reason, and that will be more beneficial for tax purposes. But the IRS is going to frown upon that kind of activity and try to put some rules in place against that. So generally rent paid in your business is deductible in the year you paid or accrued. So if you aren't accrual basis, that would mean that you pay the rent when you actually used the the business office. So if you pay rent in advance, you can deduct only the amount that applies to your use of the rented property during the tax year. So there they're putting their foot down on that one. So you can deduct the rest of your payment only over the period to which it applies. So for more information, you could take about rent. You can see chapter three of pub 535. You can find on the IRS website, iris.gov, iris.gov.