Corporation’s self-leasing rental expense deduction denied

The Tax Court holds that the payments were not for rent.
By Mark Aquilio, CPA, J.D., LL.M.

The Tax Court ruled that a corporation was not entitled to its claimed deduction for rent paid to its sole shareholder and employee for using part of his personal residence as an office. The court noted that the corporation did not produce any evidence of a written lease or other documentation indicating that the amounts were actually rent. Also, the shareholder did not treat the arrangement as a bona fide rental arrangement, as he did not report any rental income for the residence.

Facts: Christopher Ng, a physician, formed Christopher C.L. Ng M.D. Inc. and was its only shareholder and employee. Ng's personal residence in Los Angeles was the corporation's business address. The second story of the residence was used solely for the corporation's business. Ng used it as a workspace to perform administrative tasks for the corporation and to complete continuing education training and medical board certification activities.

For 2012 and 2013, the mortgage payments for the residence were made out of the corporation's bank account.

Ng timely filed the corporation's Forms 1120, U.S. Corporation Income Tax Return, for 2012 and 2013, on which the corporation deducted 100% of the mortgage payments as "rents."

On his personal income tax returns for those years, Ng claimed an itemized deduction for the home mortgage interest related to the mortgage payments. Also attached to the returns were Schedules E, Supplemental Income and Loss, reporting rental income from another property Ng owned, but none from the claimed rental of the portion of his residence.

The IRS issued a notice of deficiency to the corporation for 2012 and 2013, disallowing the deductions for rent, contending that they were mortgage payments made by the corporation for Ng's personal residence.

The corporation petitioned the Tax Court. Shortly before trial, Ng submitted to the IRS unsigned Forms 1040X, Amended U.S. Individual Tax Return, for 2012 and 2013, reporting rent received for the residence on the Schedules E.

Issue: The court was asked to determine whether the corporation was entitled to deduct the purported rental expenses.

Sec. 162(a) and Regs. Sec. 1.162-1(a) provide that a taxpayer may deduct ordinary and necessary business expenses. This may include rent paid by a C corporation to its employee or owner, the court noted. However, where there is a close relationship between the lessor and the lessee of the property, the circumstances surrounding such an arrangement must be closely examined to determine whether payments are in fact for rental of the property, the court added, citing Feldman, 84 T.C. 1 (1985), aff'd, 791 F.2d 781 (9th Cir. 1986). The court also noted that Sec. 280A, which allows a deduction for home office expenses, does not apply to C corporations.

Holding: The Tax Court held that the corporation was not entitled to the rental expense deductions it claimed in 2012 and 2013. The court found that the corporation failed to prove that its arrangement with Ng was a bona fide rental agreement, as opposed to an arrangement to make mortgage payments for the residence on his behalf, because the corporation did not produce any evidence of a written rental agreement or other documentation showing that the amounts claimed were actually rent, and Ng did not treat the arrangement with the corporation as a bona fide rental agreement because he did not report any reciprocal rental income on the Schedules E for 2012 and 2013. The court further determined that, on the record before it, it was unable to make an estimate of deductible rent expenses for 2012 and 2013 under the Cohan rule.

The court stated in a footnote that the corporation's submission of the unsigned 2012 and 2013 Forms 1040X for Ng, after the limitation period had apparently expired for 2012 and an earlier decision had been entered by the court with respect to his personal return for 2013, was "grasping at straws and is too little too late in any event."

  • Christopher C.L. Ng M.D., Inc., APC, T.C. Memo. 2018-14

— By Mark Aquilio, CPA, J.D., LL.M., professor of accounting and taxation, St. John's University, Queens, N.Y.

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