A new lease on the practice

Whether you are leasing equipment for a profitable veterinary practice or for the premises housing it, the legal and financial burden can be overwhelming. Factor in the economy and leases take on even greater importance. Fortunately, skilled negotiation can lead to your benefit when entering into new leases, restructuring existing leases — or getting out of a current one.

What's the big deal with a lease? After all, monthly rent usually is only a small part of overall costs.

But those costs add up significantly when you commit to making payments for three, five or even 10 years. The practice may no longer need that leased device, or it may move to other premises, but that doesn't take you off the hook for the contracted lease payments.

Negotiating into or out of a lease is both an economic and a legal issue.

It is the tax laws, however, that can help make any leasing strategy more affordable.

A U.S. District Court recently rebuffed the Internal Revenue Service by allowing a tax deduction for a lease-termination payment. That's good news for any veterinary practice trying to get out of an onerous lease on equipment, land, software — even leased employees. Today, lease-termination payments in many situations are immediately deductible.

Leases and federal taxes

When you purchase equipment or a building, the cost is a capital expense that generally is deductible over a depreciation period. In contrast, each lease payment usually is deductible as a current expense.

But it is not always that simple.

The first question the IRS usually asks about the transaction is whether it is a legitimate lease or an attempt to circumvent the longer write-off period for a capital expense.

Then there are rules governing "lease-related" expenses.

Although many veterinary practices routinely deduct legal fees as a current expense, the same rules that allow an immediate write-off for lease payments require special write-off periods for the expenses connected with acquiring that lease.

In other words, the cost of acquiring a lease, including all professional fees, must be amortized (i.e., written off in equal installments) over the term of the lease — including the renewal period. At least, the renewal period counts as part of the lease term if less than 75 percent of the acquisition cost is attributable to the unexpired lease period.

Lease negotiations 101

Many find their first experience in renting commercial space to be overwhelming. Commercial leases are lengthy, full of jargon and usually written to the property-owner's advantage.

But not always.

Whether the first lease, a lease renewal or the latest in a long line of lease re-negotiations, the landlord's upfront terms usually are just the starting point. Essentially, everything in the lease is negotiable, including its length, cost, rent increases, tenant leasehold improvements, renewal options, and tenant rights and responsibilities.

The key to negotiating a successful lease is knowing your needs, what the document says and being reasonable in your demands. An understanding of how the tax laws can help reduce out-of-pocket costs is useful, too.

Leasehold improvements

Tenants leasing existing space often find that it includes some usable fixtures. Generally, however, it pays to get estimates on needed improvements so that the total move-in cost is understood before you sign and can be part of the negotiations.

From a tax standpoint, leasehold improvements are considered non-removable installations, either original or the result of remodeling to accommodate the lessee. Such improvements typically are more substantial in a new space, which may consist of only concrete walls and flooring.

As part of the recent Emergency Economic Stabilization Act, lawmakers decided to bring back the former write-off for "15-year leasehold improvement property." The cost of an addition or improvement made by the tenant or landlord that becomes a structural component of the building is depreciated in the same manner and over the same period as the building. In other words, permanent walls installed in a commercial building are depreciated. Under the new, temporary rules, that means a 15-year recovery period instead of the life of the building, a 39-year period.

Leasehold additions and improvements that are not structural components usually are depreciated as "personal property" over much shorter periods, and by the one who actually foots the bill.

Remember, however, that if, upon termination of a lease, a tenant does not retain the improvements made to the leased property, a loss is computed based on the improvement's book value at the time.

Re-negotiation

Because most property owners don't want to lose tenants, especially in today's economic climate, now might be a good time to renegotiate an existing lease. Temporary rent reductions, a freeze on escalator clauses and late-penalty fees, even reconfiguring the lease's other terms are all reasonable requests.

Convincing a property owner it is more profitable for him to maintain a tenant, even at lower rents, than to find a new one, is the first step.

First, line up in advance the arguments you'll need to convince the owner to see things your way.

Profit-and-loss statements are one tool owners use to evaluate the viability of a tenant, and they are critical to lease negotiations.

So, too, is a marketing plan.

Many veterinary practices pull back on marketing when sales and profits dip. Every landlord will appreciate a tenant willing to put money and muscle into a well-crafted marketing plan.

Whether you're re-negotiating your original lease or a renewal, rely on trusted business advisers, such as your accountant and attorney, to help you weigh legal and financial decisions. Just be careful to label them either as immediately deductible legal or accounting expenses, or as lease-acquisition costs requiring a longer write-off period.

Deducting lease-termination costs

The law is clear: Any amount received by a lessee for cancellation of a lease is treated as if it were received in exchange for the lease. Not only does this apply to leases, but also to amounts received by a distributor of goods for the cancellation of a distributor's agreement.

When a tenant buys property in order to terminate a burdensome lease on it, the practice usually cannot label a portion of the cost as an immediately deductible lease-termination fee. The entire cost must be allocated to the book value or basis of the property.

In a case decided recently in a federal court, one professional practice was permitted to immediately write off a lease-termination payment tendered as part of an agreement to buy property that it was leasing. Of course, the practice first had to establish the fair market value of the property, that the lease was excessive and that the amount it paid to acquire the property over the fair market value of the property was attributable to buying out the onerous lease.

Thus, getting out of a lease, onerous or otherwise, is a viable, negotiable strategy, as well as a tactic that can produce favorable tax results.

Battersby is a tax consultant in Ardmore, Pa.