3 ways to ensure your rent is reasonable

Likely your biggest worry concerning rent is making sure it gets paid on time each month. Then, come tax time, you look forward to being able to deduct it as a business expense. But before you file those taxes, first ask yourself whether your rent is reasonable, because the IRS will.

In general, the rent you pay on a business property is deductible. This gets more tricky in cases of related party rent. Think of the practice as a separate legal entity that must pay rent to the person who owns the legal entity. It is considered a related party payment if the legal entity and the person who owns the legal entity are the same person. The IRS often closely scrutinizes related party rent, and if an agent thinks you're paying yourself too much, he or she will reduce your deduction, often recharacterizing the excessive rent as a distribution of profits or a gift. To help you prove your rent is reasonable, take these steps when establishing a rental agreement.

1. Compare your property. One way to establish that you're paying reasonable rent is to demonstrate that it's in line with what others pay for property similar to yours. To show this, have an independent real estate agent or broker appraise several comparable properties. If the results are less than what you'd hoped for, carefully document why your property should be valued higher. You can make a good case if you've substantially improved the site or added special features or if you're in a highly desirable location. The industry standard for rent is 10 percent to 12 percent of the fair market value of the property under a triple net lease. A triple net lease means the practice pays the property taxes, utilities, and insurance in addition to the rent.

2. Find your true profitability. Establishing proper rent also helps you determine your practice's true profitability. This makes it easier to figure out the cash flow you should expect as a return on investment and to calculate the value of your practice.

3. Write it down. Here's the most important step you need to take: Set the rental agreement down in a properly executed, formal written lease. In several IRS tax court cases, the government has disallowed rent paid to a related party because it wasn't included in a formal lease. Properly researching and documenting your transaction can go a long way toward establishing the reasonableness of your rent. And be sure to consult your tax advisor and attorney.

Veterinary Economics Editorial Advisory Board member Gary Glassman, CPA, is a partner with Burzenski & Co. in East Haven, Conn., and specializes in veterinary accounting and tax planning.