Landlords will often offer inducements to commercial tenants to sign long-term leases. Common types of inducements are:
These inducements result in differing accounting and tax treatments, which may not follow the actual cash flows.
For accounting purposes, any immediate cash outlay (e.g., renovations, allowances paid to tenants) will generally be recorded as an asset and expensed over the term of the lease. If a lease includes a free rent period, the total expected revenues from the lease are recognized on a straight-line basis over the term of the lease (including the free rent period); resulting in a receivable being setup during the free rent period, which is then reduced once rent is collected from the tenants.
For tax purposes, tenant inducements may be considered capital expenditures, expenditures to be deducted over the lease term or expenditures to be deducted as incurred. If the landlord directly incurs the renovation costs, then the renovation may be considered a capital improvement and treated as an addition to the Capital Cost Allowance pool. Depending on the nature of the payment, if there is a cash outlay that is not capital-in-nature (e.g., allowance paid to the tenant), then it may be deductible as incurred or over the term of the lease.
In the case of free rent, since there is no actual cash outlay, the free rent period is generally ignored for tax purposes, and the rental revenue is recorded based on the actual cash received.
If you are a landlord that offers tenant inducements, please contact us for further information.
Disclaimer: We caution that the above is a high level analysis and should not be construed as advice. There are several tax and other considerations beyond the scope of this article that would need to be considered in each situation.