Do You Own Your Building and Your Business? Read This.
A lot of business owners structure things in a smart way. They set up one company to own the building and another to run the business. The operating company pays rent to the property company, and on the surface, it feels neat and tidy.
But when it comes to your financial statements, this arrangement can create unexpected problems. Recent lease accounting rules now require companies like yours to handle these “renting from yourself” situations in a very specific way. If you do not have the right paperwork in place, it could cause tax or audit issues.
What Changed
Private companies began following new lease accounting rules under ASC 842 starting in 2022. These rules require businesses to record a “Right of Use” (ROU) Asset and a Lease Liability for most leases. That means even if you rent from yourself, it still needs to be reported on your financial statements.
The problem was that many business owners did not have a formal lease agreement between their property company and their operating company. Auditors were left unsure how to treat these related-party leases.
In March 2023, the Financial Accounting Standards Board (FASB) issued a mandatory clarification for fiscal years beginning after December 15, 2023. This guidance is now being applied to the 2024 financial statements and will continue forward. The clarification allows private companies to use the written terms of an arrangement, even if those terms are not legally enforceable, to determine the lease accounting.
The clarification also fixed a major problem concerning leasehold improvements. Previously, if your property company had a short, one-year lease, any major renovation, such as a new roof or HVAC system, had to be expensed over that single year, even if the equipment would last 15 years. The new rule allows you to amortize those improvements over their full useful life to the common control group. This is a significant financial win for many family-owned businesses.
The Importance
- Auditors Need Clarity: If your lease agreement between related entities is vague or unwritten, auditors cannot make assumptions. Without a written agreement, the practical expedient cannot be used, and auditors will fall back on legally enforceable terms, which often default to month-to-month treatment.
- Impact on Your Numbers: That default treatment can change how your assets and liabilities appear, which can affect how lenders or investors view your financial strength.
- Hidden Win on Improvements: The ability to amortize major improvements over their useful life gives you more predictable expenses and avoids big one-year write-offs.
- Ongoing Risk: An informal setup may seem easier in the short run, but it creates inconsistencies in your financial statements year after year. That raises questions you do not want in an audit or loan review.
What You Should Do Now
- Review Your Lease Agreements: If your operating company rents from your property-owning LLC, do you have a written, enforceable lease agreement?
- Check the Lease Term: Is it just one year that automatically renews? Make sure the wording is clear.
- Talk to Your Auditor or CPA: Confirm how they are applying ASC 842 for your leases and how they are treating any improvements made to the building.
- Formalize Informal Agreements: If your lease agreement is verbal or loosely defined, consider putting it in writing. A written agreement gives you predictability, reduces audit risk, and keeps your financial statements consistent.
This lease clarification may sound like an accounting technicality, but for business owners, it has very real consequences. If you own both your building and your business, the way you set up your lease agreement matters now more than ever. And the good news is that the update brings not only clarity but also real financial benefits, especially if you invest in your property.
At Supporting Strategies, we help owners navigate rules like ASC 842 so your books reflect the reality of your business without creating audit headaches. Taking the time to formalize related party leases today can save stress, money, and confusion tomorrow.
Leave a Reply
Want to join the discussion?Feel free to contribute!