Lease Concessions: Tax and Accounting Treatment

A lease concession is a financial incentive a landlord offers to attract or retain a tenant. Landlords use these inducements to make a property more appealing, particularly in a competitive rental market or during economic downturns. The purpose is to secure a lease by providing a benefit that reduces the tenant’s initial costs or overall financial burden, which helps fill vacancies and maintain occupancy rates.

Common Types of Lease Concessions

Landlords may offer several types of concessions to make a lease more attractive.

• A period of free rent, where a landlord might offer one month free on a new twelve-month lease. This gives the tenant occupancy for the full year while only requiring eleven months of payment, directly lowering their immediate cash outlay.
• A rent abatement or reduction, which lowers the amount of rent due for a set period. A landlord might reduce the monthly rent by a percentage or a fixed dollar amount for the first few months of the lease term.
• Tenant Improvement Allowances (TIAs), a common concession in commercial real estate where a landlord provides funds to customize the leased space. This allowance, often calculated per square foot, allows a business to create a functional environment without bearing the full upfront cost of renovations.
• Waiving fees normally charged to new tenants, such as application fees for background checks or amenity fees for access to facilities. In residential leases, this can also include pet fees or monthly parking charges.
• Moving expense reimbursement, where a landlord offers a direct payment or credit to help offset the costs of hiring movers or renting a truck. This provides a tangible financial benefit that addresses an immediate relocation expense.

Landlord Accounting and Tax Treatment

For financial reporting, landlords must recognize rental income on a straight-line basis over the entire lease term, regardless of when cash is received. This accounting principle, guided by standards like ASC 842, smooths out the effect of concessions. For example, if a landlord grants one free month on a 12-month lease with a $2,000 monthly rent, the total rent is $22,000. The landlord recognizes $1,833.33 ($22,000 / 12) in revenue each month instead of zero in the first month.

This straight-line method creates a difference between the cash collected and the revenue reported. During a free period, the landlord reports income without receiving cash, creating a rent receivable on the balance sheet. As the tenant begins making cash payments that exceed the recognized monthly revenue, this receivable is reduced.

From a tax perspective, concessions reduce a landlord’s taxable income. The value of a free rent period or rent reduction directly lowers the total rental income reported to the IRS. For cash-basis taxpayers, income is reported when received, so a free month results in no taxable income for that period. For accrual-basis taxpayers, the tax treatment aligns with the straight-line accounting method, governed by rules under Internal Revenue Code Section 467 for leases over $250,000.

Tenant Improvement Allowances receive specific tax treatment. The funds a landlord provides for a TIA are capitalized as part of the building’s cost basis instead of being an immediate expense. This amount is then depreciated over the property’s statutory life, which is 39 years for nonresidential real property. This allows the landlord to recover the cost through gradual tax deductions.

Tenant Financial and Tax Considerations

Business tenants must also follow specific accounting rules for lease concessions, which mirror the landlord’s treatment. Companies are required to recognize rent expense on a straight-line basis over the lease term. This creates a consistent monthly expense on the income statement, ensuring that financial statements accurately reflect the cost of the lease regardless of the timing of cash payments.

For example, if a business receives three months of free rent on a three-year lease, the total rent expense for the 33 paid months is divided by 36 to determine the monthly expense to be recorded. This creates a deferred rent liability on the tenant’s balance sheet during the free rent period. This liability is then reduced over the remainder of the lease term as cash payments are made.

For residential tenants, concessions like a free month of rent or a rent reduction are not considered taxable income by the IRS. They are treated as a reduction in a personal living expense. Because rent for a primary residence is a non-deductible personal expense, a tenant does not need to report the value of the concession on their tax return. The same logic applies to waived fees or other direct reductions in the cost of the lease.