The Importance of Understanding § 467 Leases
October 27, 2016
Regardless of the work you do or industry you serve, there is a strong chance that rent makes up a significant portion of your company’s expenses and liabilities. And, that your lease agreement is longer than a single year. Is your firm correctly accounting for long-term lease liabilities if total rent payments are in excess of $250,000?
Accounting for long-term property leases can be tricky. It is important to understand when lessees and lessors should follow the lease agreement and when to account for what is known as “rent leveling.” Without proper attention to long-term leases, you could be reporting lease accruals incorrectly. Most common errors come from lessors and lessees with specific rental agreement increases or deductions such as rent abatement, yearly increases, or even improperly accruing rent. Below are several items to consider to determine if IRC § 467 applies to your lease.
When it Applies:
Current regulations state that rent leveling accounting applies to everyone whose fixed rent payment totals are in excess of $250,000 over the lease agreement’s lifespan, as well as for leases that do not require equal payments across the lease term.
So what does this actually mean? The premise stems from the idea of treating long-term leases equally over their lifespan. This allows for concrete reporting standards with little deviation for deferral of income for the lessor. In essence, this creates the need for equal accruals even if there is a temporary difference when compared to the cash payments made by the lessee. Eventually the temporary difference between cash and accrual payments will reverse and match at the end of the lease.
Rent Leveling:
The term rent leveling is used to prescribe the above-mentioned premise that a lessee and lessor average the accruals throughout the life of the lease. For instance, a lessee might be awarded several free months of rent in the beginning of the rental agreement, but rent leveling will factor those savings over the entire life of the lease for reporting purposes. Additionally, the lease may rise a fixed percentage from year-to-year. Again, rent leveling will average these payments over the life of the lease in order to equalize all accruals regardless of year. This process is crucial to reporting accurately under §467, but should not affect actual cash payments.
Got questions? Connect with an experienced Aprio advisor today.
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