Lease negotiations are a matter of tax.

In the give-and-take of commercial lease negotiations, both the landlord and the prospective tenant come to the table with a number of issues that must be resolved. Which party will pay for tenant improvements? Will the landlord pay some of the tenant's moving expenses or professional fees? Who will pay the tenant's rent during the remaining term of an old lease? The resolution of these economic issues usually has tax implications that even the savviest of negotiators may overlook.

The question of who will pay for tenant improvements involves a negotiation process where each party attempts to favorably balance tax considerations with economic needs. In general, where improvement of the rented space is necessary, either the landlord will fund the cost and receive a higher rent or the tenant will pay for improvements with the trade-off of a lower rent. The cost of improvements to leased commercial premises is generally not currently deductible, but must be depreciated ratably over a 39-year period, or a shorter time if the improvements are in the form of tangible personal property such as desks or computers. So, from a tax perspective, if the landlord collects a lower rent and has the tenant pay for the improvements he could, in effect, deduct the cost over the term of the lease as opposed to the 39-year period. Moreover, the landlord's up-front investment is reduced if the tenant becomes a credit risk. However, if the landlord needs to show a higher rent role for existing or anticipated financing purposes, the tax issue takes a secondary role.

In the same way, the tenant must weigh similar tax issues -including commercial rent tax - with non-tax considerations such as financial reporting and borrowing capacity, which likewise could override the tax issue. An additional tax consideration is whether the lease is renewed at its expiration - if not, the tenant may write-off any costs not already taken, while the landlord may do so only if the improvements are demolished.

Another issue often negotiated is the question of moving expenses and lease-related professional fees. If the landlord pays, he can achieve a fairly rapid write-off of these cash outlays as long as it is to or for the benefit of a tenant and the tenant has discretionary use of the funds. Under this scenario, the landlord can apportion the write-off of the cost over the term of the lease, irrespective of the tenant's renewal or extension option. In taking advantage of this rule, the landlord is not limited to moving expenses and lease-related professional fees - it applies to any cash outlay in which the tenant has discretionary use of funds. The tenant, on the other hand, will be treated as receiving current income and will get a current deduction only if and to the extent the funds are used to pay business expenses. However, if the tenant uses the funds to purchase long-lived assets, such as tenant improvements, the deduction must be spread over a period of time.

On the matter of who assumes the new tenant's future obligations under an existing lease, typically the landlord does. Although the landlord is entitled to deduct these payments, the law is unclear on whether the payments can be deducted either when they come due or ratably over the term of the new lease. If the landlord makes a lump-sum payment to terminate a new tenant's continuing prior obligations or to terminate an existing lease, then the uncertainty is whether the write-off may be deducted over the term of the new lease or the old lease. When the tenant makes a lease termination payment, it will generally produce a current deduction. However, the IRS has recently asserted that such payments may have to be deducted over a longer period of time. In order for a tenant to obtain a current write-off for undepreciated improvements at the old premises, it is important that the landlord legally assume the tenant's future obligations under the old lease rather than structure the arrangement as a sublease.

These issues are by no means exhaustive. For example, free rent periods - referred to as tenant rent holidays - and the timing of rental payments, generally play a large role in lease negotiations. However, you should be aware that special tax rules may substantially alter the treatment of these, as well as other lease terms. In addition, whether improvements are characterized as real or personal property can have a significant impact on the after-tax cost.

Another major issue that may influence the ultimate lease structure, regardless of the tax implications, is financial reporting under generally accepted accounting principles. Also, sales tax, commercial rent and occupancy tax, utility tax, third party creditor matters, as well as the tax posture of the parties - such as loss carry-forwards or tax-exempt tenants - could affect the negotiations.

The negotiation and decision-making process can pose vexing problems and should be analyzed in the same way you would any business investment decision. In the landlord's case, determine the after-tax cash inflow - or outflow in the tenant's case - of each alternative lease structure. Then calculate and compare the present value of these cash-flows to determine which alternative produces the greatest after-tax cash benefit or lowest after-tax cost. Practically speaking, the landlord and tenant each try to negotiate the best deal from both a business and tax perspective. Come to the table armed with knowledge, as well as a tax advisor, and you will be prepared to negotiate a deal that is most beneficial to you.

(CPA and attorney Daniel A. Shapiro, a principal in David Berdon & Co. LLP's tax department, works closely with the real estate industry. David Berdon & Co. LLP, an 80-year-old New York City based accounting and consulting firm, is ranked among the 25 largest CPA firms in the nation. The firm offers a full range of accounting tax, financial, and consulting services, with special expertise in estate and succession planning, shareholder agreements, business management, and litigation and business valuations.)