In order to limit liability, many tax professionals and attorneys offer simple advice to their business clients who also own real estate. In order to avoid exposure to valuable real estate, many business owners are advised to segregate the risky business operations into its own legal entity separate from the real estate. While it may be worthwhile from a business liability standpoint, it is often a recipe for disaster for Florida sales tax purposes.
Florida is the only state that taxes commercial rent. In fact, many tax professionals take it a step further. Man times, for federal tax and cash flow purposes, attorneys set up a lease between the real estate entity and the business entity, often equal to the mortgage, insurance, and property tax costs. In other situations, 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. Whether there is a lease, or if the tenant company pays the expenses directly, or even if the companies are related then Florida sales tax still applies. Below are 4 simple rules to keep in mind when it comes to Florida sales tax on commercial rent
Rule #1: Rental payments are subject to Florida sales tax. This is the simplest rule to remember. Notice how there is no limiter for related parties but rather I stated that say rental payments are subject to Florida 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: Expense payments made by the tenant (the business) which are paid on behalf of the landlord (the real estate company) 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 rent be paid. This is an effective rule to remember for related parties. 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.
Like most state agencies, the Florida Department of Revenue (“FL DOR”) has a system to catch those that violate one of those rules. The FL DOR runs a report that determines who owns a particular piece of real estate from the Country Property Appraiser’s office. It cross-references that report against occupational license by address. If the property owner is different than the occupational license business or the FL DOR sees that the owner is not registered, then it sounds out an inquiry letter to the business s owner. This is when my phone rings. 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 Tallahassee.
On the positive side, the rules can be used to your advantage. 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.
About the author: Mr. Donnini is a multi-state sales and use tax attorney and an associate in the law firm Moffa, Gainor, & Sutton, PA, based in Fort Lauderdale, Florida. Mr. Donnini’s primary practice is multi-state sales and use tax as well as state corporate income tax controversy. Mr. Donnini also practices in the areas of federal tax controversy, federal estate planning, Florida probate, and all other state taxes including communication service tax, cigarette & tobacco tax, motor fuel tax, and Native American taxation. Mr. Donnini is currently pursuing his LL.M. in Taxation at NYU. If you have any questions please do not hesitate to contact him via email JerryDonnini@Floridasalestax.com or phone at 954-642-9390.