How to Deduct Business-Travel Expenses the RIGHT Way -
Watch Out for the "True Lease" Trap!
1 of 2: I am trying to get my arms around the North
American trip rules, specifically the 51/49 primary purpose
If my trip in the IRS-defined North American area is for seven
days or less and includes one business day, does that one
business day make for a deductible business trip?
Answer - It makes for deductions meaning your word
"trip" defines what you think you've done, but tax law breaks
the word trip or travel into two components, as shown in the
Transportation (costs of getting to and from the
Business-day costs (meals, lodging, and other costs
of sustaining life on business days)
Yes. With one business day on this seven-day trip, you pass
the 51/49 test, and that qualifies you to deduct the entire
cost of getting to and from this business destination.
Question 2 of 2: Originally, this question was
intertwined with the first question. We broke this apart to
facilitate understanding. Here's the second question.
So the 51/49 rule makes my trip a business trip, and I deduct
100 percent of the airfare and lodging. And then I deduct
meals and expenses on the business days as though the entire
trips is business. Yes?
Answer - No. First, you deduct the cost of getting to
and from the business destination under the 51/49 test. This
includes airfares, taxis, rental cars, and lodging en route.
Once you arrive at the destination, you deduct your
business-day expenses for meals, lodging, and other costs of
sustaining business life. You deduct nothing for the personal
Example. You travel to St John in the U.S. Virgin
Islands. This is a foreign destination under the business
travel rules; thus, the 51/49 rule applies to your
transportation if your trip is for 7 days or less, excluding
the day of departure.
Including travel, your trip involves three business days and
four personal days. You deduct all costs of getting to
and from St. John and all food, lodging, and other costs of
sustaining life during your business days. You deduct
nothing for your personal days.
Planning note. On this trip, if a personal day is
sandwiched by two business days, the rules convert the
personal day into a business day.
Trap to Avoid:
Leasing When You
Thought You Were Buying-or Vice Versa
2004, a gentleman named Arthur Boyce walked into an Idaho Ford
dealership and purchased a new Expedition truck for his
business. Or so he thought.
The IRS found that the
arrangement didn't really transfer an ownership interest to
Result: The court agreed
with the IRS and ruled that Mr. Boyce had actually leased the
truck and denied him a Section 179 deduction for its cost.
Moral - It doesn't matter what you call it. It doesn't
matter what you intend. It matters what is.
You need to make sure you don't accidentally lease the vehicle
you think you're buying or buy the vehicle you think you're
leasing. This article will help you do what you want to do by
showing you the trap and how to avoid it. But first, let
examine why it's important to get this right.
Why Getting the Transaction Right Matters
Ensuring that vehicle "leases" are true leases and "purchases'
are true purchases isn't just a formality. At stake is a lot
of money in or out of your pocket. That's because leases and
purchases often have significantly different tax consequences.
The catch: The lease must be a "true lease." For the IRS (and
the courts), it's a matter of substance over form. In other
words, it's not what you call it, it's not what the lessor
calls it, but it's the "objective economic realities of the
transaction" that determine whether your transaction is a
purchase or a lease for tax purposes.
If a lease isn't a true lease, the IRS will re-characterize
the arrangement as a purchase and will not let you claim the
rent payments as business deductions under IRe Section
course, the same thing can happen in reverse when the
IRS re-characterizes a purchase as a lease and disallows
the deductions for purchasing the vehicle under IRS
Section 179. This is what happened to Mr. Boyce.
What's a "True Lease"-the IRS's Five Red Flags
A "true lease" is one in which you pay to use the vehicle and
not to obtain ownership of it. There are five red flags of
ownership the IRS looks for in determining whether a lease is
really a sale in disguise.
1. Rent Payments Build Equity
To be a true lease, no part of the required "rent" payment can
count as equity.
Example. The IRS said and the court agreed that you have a
purchase and not an equipment lease when a portion of the rent
payments made in Year 1 count as equity in the formula to
calculate rent for Year 2.
2. You Get Title after Making Rent
Another red flag against the lease is a provision that
purports to give you ownership of the vehicle after you pay a
designated amount/percentage of rent due.
Example. The IRS says that your lease is a purchase agreement
when you get title to the property when total monthly rent
payments equal a stated amount.6
3. Amount You Pay to Lease Is About
the Same as the Amount You'd Pay to Buy
Since you're paying for use of the vehicle over a relatively
short period, the expectation is that total rent payments will
be much less than what you'd pay to buy the vehicle. So it's
hard to justify as a true lease an arrangement where total
rent is anywhere near what you would pay to buy the vehicle
Example. In Revenue Ruling 55-540, the IRS cites Bov.en, in
which the court ruled that when six months' worth of rental
payments equaled the value of the leased equipment, the lease
was a sham and the lessee bought the equipment
4. Rent Amount Is Much Higher than
Fair Market Rent
A corollary to number 3 above is the principle that you can't
have a true lease where rental payments are way above the
current fair rental value.
Example. Say that fair rent is $300 a month, but you pay $900
a month. The IRS says that excess rent indicates fishy
business, likely a purchase rather than a lease.
5. Buy for a Song
Another way to taint the integrity of the true lease is to
allow the lessee to buy the vehicle at lease-end for a nominal
amount. The obvious suggestion: the rental payments were
actually made to buy the vehicle.
Example. You rent equipment with an expected useful life of 10
to 15 years. You do not have a true lease when after five
years of renting you can renew the lease for up to 10 years
for $1 a year.
True Lease and Option to Purchase
If, like most vehicle leases, your lease includes an option to
purchase, it's important to note that such options are not on
the IRS's red flag list. In other words, a true lease can
include an option to purchase as long as the price you pay
reflects the vehicle's fair market value.
One way to make sure of this is for the purchase option to
reflect the vehicle's "clean value" (i.e., the value listed in
the National Auto Research Black Book).'
True Lease Rules for Closed-End
In this form of lease, the purchase price of the vehicle is
set at the time you sign the lease.
Rule. The option price is considered fair market value for
true lease purposes if you can buy the vehicle at its
projected end-of-lease residual value." You negotiate
and set the residual value and corresponding option price when
you sign the lease.
True Lease Rules for Open-End Leases
With this type of lease, you estimate the vehicle's residual
value when you sign the lease and wait until the lease
actually ends to determine the vehicle's actual residual
value--and your liability:
• If actual residual value is higher than the estimate, you
pay the difference.
• If actual residual value is lower than the estimate, you get
In other words, in open-ended leases you (not the lessor) bear
the risk of decline in vehicle value. Taking on the decline in
vehicle value is like owning the vehicle, not leasing it. But
lawmakers created an exception for this type of lease.
In 1982, 1984, and 1986, lawmakers enacted laws saying
open-ended vehicle leases that include clauses adjusting the
rental price up or down based on the amount that the lessor
can sell the vehicle for at the end of the lease (the way
open-ended leases do) can be considered true leases when all
of the following five conditions are met:
1. You lease a car, truck, or trailer.
2. You certify in writing to the leasing company under penalty
of perjury that you'll use the vehicle more than 50 percent of
the time for business.
3. The leasing company certifies in writing that it told you
that you're not the owner of the vehicle for tax purposes.
4. The leasing company has no knowledge that your
certification is false.
5. The leasing company has a tax-law-defined liability in the
There's more to the lease versus buy conundrum than choosing
between them. Once you decide whether to buy or lease, you
face the challenge of ensuring that the transaction is really
a purchase or a lease.
If what you intended as a lease turns out to be a purchase or
vice versa, you could end up not only losing out on the
valuable tax benefits you thought you were getting but also
owing the IRS interest and penalties.
If you don't believe it, just ask Mr. Boyce.
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always you can call me at 714-619-0667 if you have any
questions about investing, retirement or any other tax &
accounting related issues.
Regards, Monica Rebella, CPA/IAR
President, Rebella Accountancy