Renegotiating Commercial Rent Due to COVID-19? Don’t Pay More Sales Tax Than You Need To!
Florida is the only state in the country to impose sales tax on commercial rent. Of all those businesses affected by the pandemic, those involved in commercial real estate may be some of the worst affected. With retailers closing shop, entertainment essentially banned, and offices moving remote, many commercial buildings have become deserted. Furthermore, those business which do remain are likely not paying rent due to the moratorium on evictions. With few options for new tenants, commercial landlords are motivated to work with nonpaying current tenants to renegotiate lease terms to encourage tenants to stay. If your business has been suffering due to the pandemic but your commercial space is still necessary, it may be in your best interest to engage in a renegotiation of lease terms. However, don’t make the common mistake that many Florida business owners do and create a large sales tax liability for yourself in the process.
Florida imposes sales tax on commercial rent pursuant to section 212.031, Florida statutes. Specifically, the statute provides that “every person is exercising a taxable privilege who engages in the business of renting, leasing, letting, or granting a license for the use of any real property.” While there are certain exemptions available, such as leases for dwelling units, most exemptions are narrow in nature. Resultingly, most commercial leases in Florida are subject to the state sales tax and local surcharge.
Because the imposition of sales tax on commercial rent is exclusive to Florida, it is easy to fly under the radar. Most Florida businesses are aware of this imposition of sales tax on commercial rent. Meanwhile, out-of-state businesses are often unaware of the tax altogether, occasionally only discovering their error upon audit. However, even those seasoned Florida taxpayers who are familiar with the imposition of sales tax on commercial rent often do not understand the application of this unique tax to lease termination fees.
For various reasons, a landlord and tenant may enter into a lease termination. Sometimes a tenant’s space requirements change, so they decide to either upsize or downsize their square footage. The lease will need to be adjusted to account for the change in square feet, so the landlord and tenant prepare a new agreement. If the space has more square footage, the landlord will probably be inclined to tear up the current lease agreement and create a new one that takes over from the old lease on the day of signing. However, if a tenant is downsizing, the landlord may want a fee paid to allow the tenant to break their current lease for one with a cheaper rental payment to recoup at least a portion of the loss they are incurring from not receiving payment for the more expensive lease. Such fees are commonly referred to as lease termination fees and whether the lease refers to these fees as "rent" makes a big sales tax difference.
Usually these lease termination fees are already agreed upon and memorialized in the original lease. For example, a 12-month commercial lease requires tenant to pay $100,000 per month in base rent, and $400,000 to terminate the commercial lease at any time. If the lease agreement states that this $400,000 fee is to cover unpaid rental payments, then this $400,000 is subject to Florida sales tax. However, if the $400,000 lease termination fee is simply a fee to break contract, then such fees are not taxable. In this example, wording on a contract could save, or cost, $24,000!
Prior to COVID-19, if the lease termination fee was already established in an original contract, it may not have been an option for a tenant to get out of paying tax on this fee if the charge was identified as for unpaid rent. However, during the pandemic, virtually all commercial leases were thrown into question. Landlords are more motivated than ever to work out an arrangement with tenants to avoid defaulting on their own mortgage payments. There is an opportunity for the landlord to negotiate a small change in the lease prior to termination so the termination fee is specifically referred to as "not rent" in the lease. The landlord could motivate the tenant to accept the change by splitting the sales tax savings!
Taxpayers who are discussing modifying a lease agreement going forward can create a new lease in which they add, in addition to the new rental amount, a fee for terminating the prior lease. This new fee should replace any previous lease termination provision in the original lease. This way, a landlord and tenant can work together in coming to the agreement that any lease termination fee is a price paid to terminate a contract, not a price paid to cover unpaid rent. In desperate times, that $24,000 savings mentioned above can make a big difference to a taxpayer who already cannot afford their rent under their original lease agreement.
For those who have already paid lease termination fees under unfavorable lease agreement terms, it is important to make sure that any tax was paid if it was due. The Department of Revenue almost always looks for tax paid on commercial rent when conducting an audit of a business. If they catch you under audit, you will be assessed not only tax, but also interest and steep penalties. Fortunately, if you act quickly, you can engage in a voluntary disclosure if you are not under audit. A voluntary disclosure can save you paying those costly penalties if it is done properly.
About the Author: Jeanette Moffa is an attorney who concentrates on state and local taxes at Moffa, Sutton, & Donnini, P.A. She is an executive council member of the American Bar Association Tax Section State and Local Tax Committee and the Florida Bar Tax Section. Ms. Moffa is an author of both the CCH’s Expert Treatise Library: Sales and Use Tax as well the ABA’s Sales and Use Tax Deskbook. In addition, her regular columns on state and local tax issues can be found in State Tax Notes and Actionline, a publication from the Florida Bar’s Real Property, Probate, and Trust Law Section. She also serves as assistant editor to the Sales and Use Tax Deskbook and Actionline. Ms. Moffa is a regular speaker at the American Bar Association Tax Section conferences, the Institute of Professionals in Taxation, the Florida Bar Tax Section, the Florida Bar Real Property, Probate, and Trust Law Section, and the FICPA.
At the Law Office of Moffa, Sutton, & Donnini, PA, our primary practice area is Florida taxes, with a very heavy emphasis in Florida sales and use tax. We have defended Florida businesses against the Florida Department of Revenue since 1991 and have over 100 years of cumulative sales tax experience within our firm. Our partners are both CPAs/Accountants and Attorneys, so we understand both the accounting side of the situation as well as the legal side. We represent taxpayers and business owners from the entire state of Florida. Call our offices today for a FREE INITIAL CONSULTATION to confidentially discuss how we can help put this nightmare behind you.
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AUTHORITY
Rule 12A-1.070(4)(b), Fl. Admin. Code
212.031, Fla. Stat. Tax on Rental or License Fee for Use of Real Property
ADDITIONAL RESOURCES
Florida Sales Tax Rate on Commercial Rent 2020, by James Sutton, CPA, Esq., Published January 6, 2020
How to Calculate FL Sales Tax on Rent, by Michael Moffa, Esq., Published April 11, 2019
FL Sales Tax vs Restaurant Management Agreements, by Jeanette Moffa, Esq., Published October 29, 2018
FL Gov Scott Calls for Phase Out of Commercial Rent Sales Tax, by James Sutton, CPA, Esq., published January 29, 2014
Is Rent Subject to Florida Sales Tax?, by Jerry Donnini, Esq., published January 26, 2015