FLORIDA SALES TAX ON RENT
Many corporate attorneys advise their clients that own real estate, to segregate the business operations into its own legal entity separate from the real estate. The reason is a simple one. Separate companies that own an operating business and another that owns real property is an effective tool to protect the real estate from liabilities of the operating business. Florida is the only state that taxes commercial rent, so it is not surprising that most attorneys do not have Florida sales tax on their minds when structuring asset protection schemes. The opposite is true from a Florida sales tax attorney's perspective.
Putting asset protection aside, separate entities for real estate can create unwanted sales tax consequences for any Florida business. Often for both federal tax and cash flow purposes, many attorneys set up a lease between the real estate entity and the business entity, often equal to the mortgage, insurance, and property tax costs. Other times, and often with no formal lease in place, the corporate attorney will just have the business entity pay the mortgage, property insurance, and real estate taxes directly on behalf of the real estate company.
So what's the problem? Is related party rent subject to sales tax? Are property expense payments on behalf of another company subject to tax?
From a Florida sales tax attorney's perspective there are a couple of helpful rules to keep in mind to help answer those questions.
Rule #1: Rental payments are subject to Florida sales tax. Notice how I didn't say rental payments between unrelated entities are subject to tax. Therefore, whether or not the two entities are related or have common owners, any rent being paid is subject to Florida sales tax.
Rule #2: Property expense payments paid on behalf of another are subject to Florida sales tax. Whether the business entity pays the real estate entity rent, which is then used to pay the mortgage, property insurance, and real estate taxes directly, or if the entity that owns the operating business pays those amounts directly (called "constructive rent", it is considered rent in either case).
Rule #3: There is no requirement that related entities charge rent. Florida sales tax only applies to rent or constructive rent actually paid.
Rule #4: Unlike federal tax law, there is not Fair Market Value requirement for Florida sales tax purposes.
The Florida Department of Revenue ("FL DOR") has a nifty system to catch those that violate one of those rules. In fact, the FL DOR runs a report that it obtains from the Country Property Appraiser's office that lists property owners by address. It then compares that report by occupational license by address. If those entities do not match and no sales tax on rent is being collected, the FL DOR gets curious and sends a letter asking why. As mentioned above, most attorneys and even tax professionals are not aware of at least 1 of those 4 rules when it comes to Florida's commercial rent tax. As a result, we receive calls almost weekly in which someone has misunderstood at least one of those rules and/or an inquiry letter from our Tallahassian friends.
On the positive side, knowing those rules well can also give rise to some savings opportunities. In the related company example, what if the operating business paid no rent or only minimal rent? To cover cash-flow, what if the business entity made a profit distribution to its owners and the owners simultaneously contributed the money back into the real estate entity? Pursuant to the rules above, then the real estate entity may only owe a nominal amount, if any, of sales tax.
To put numbers to my hypothetical consider the following two scenarios:
Scenario 1: AB Manufacturing Co pays rent of $20,000/month to AB Land Co which is equal to AB Land Co's real estate expenses. AB Man. Co would be on the hook for $1,200/month in sales tax or $14,400 per year, or $43,200 for a 36 month audit period (assuming 6% county).
Scenario 2: If AB Man Co paid rent of $1,000 and the balance was a properly timed profit distribution and contribution back into AB Land Co, AB Man. Co would only owe $60/month in sales tax, which would result in savings of $41,040 for a 36 month audit period.
Due to Florida's unusual treatment of imposing a sales tax on commercial rent, if often gets overlooked in asset protection transactions. Many unrelated businesses get caught off-guard when they owe sales tax on top of their real property expenses due under a triple net lease (usually real estate taxes). Whether it is a result of an inquiry letter or the result of an audit, the FL DOR often goes after companies because commercial rent is such low hanging fruit. With proper planning, many companies can abate or eliminate a sales tax on commercial rent problem.
If you or your client are going through an audit and are facing these issues, then there are ways to negotiate down the assessment if you have local, experienced counsel. Depending on your fact pattern, there may even be ways to argue some of the amounts paid should not be considered rent (such as the arguing part of payments should be considered interest instead of 100% rent). Or, if you or your client has received an inquiry letter from the FL DOR then there are often things that can be done to help eliminate or mitigate exposure. Even if you or your client knows of an existing commercial rent problem then there are things that can be done to mitigate the damage. Any position we might be able to argue for you is very fact specific and a free consultation may reveal ways to lower the tax assessment. However, there are many situations in which proper planning can eliminate or significantly reduce a whole owned group of company's state tax liabilities on related party leases.
If you have any questions about this article, then please don't hesitate to our firm for a FREE INITIAL CONSULTATION.
AUTHORITY
Sections 212.02(12), 212.031 Florida Statutes
Rule 12A-1.070 Florida Administrative Code
US Cardio Vascular Inc vs Florida Department of Revenue, Case No 1D07-3811 (1st DCA, Sept. 23, 2008)
Solano vs Florida Department of Revenue, DOAH Case No 03-4272 (March 17, 2004)
Technical Assistance Advisement 11A-020 – June 21, 2011
Technical Assistance Advisement 09A-048 – September 29, 2009 (Intercompany Rental Implied)
Technical Assistance Advisement 04M-002 - November 16, 2004 (Capital Lease vs Rental Lease)
ADDITIONAL RESOURCES
FL GOV SCOTT CALLS FOR PHASE OUT OF COMMERICAL RENT SALES TAX, published January 29, 2014, by James Sutton, CPA, Esq.
FL CONDO/TRANSIENT RENTAL INDUSTRY – SALES AND USE TAX ISSUES AND SAVINGS OPPORTUNITIES, published April 17, 2012, by Jerry Donnini, Esq.
FL TAA ALERT – SALES T0041 ON RENT – INVERSE PYRAMIDING?, published December 15, 2012, by James Sutton, CPA, Esq.
FL TAA ALERT – RENT FREE MONTHS vs SALES TAX?, published November 11, 2012, by James Sutton, CPA, Esq.
FL TAX – VOLUNTARY DISCLOSURE CAN BE THE PERFECT SOLUTION, published October 5, 2012, by Jerry Donnini, Esq.
WHAT SEVICES ARE SUBJECT TO SALES TAX IN FLORIDA, published May 1, 2012, by James Sutton, CPA, Esq.
FLORIDA COMMERCIAL PROPERTY OWNERS GET BLINDSIDED BY SALES TAX, December 31, 2011, by James Sutton, CPA, Esq.