Taxpayer-lessor in constructive receipt of rental income from wholly owned corporation.

• Author: Vitale, Dan M.

Many cash-basis individual taxpayers own real estate that they rent to their wholly or family-owned corporations. The ownership of real estate outside of the corporate legal entity has various advantages, including, for example, the facilitation of estate and gift tax planning, and the insulation of the real estate from the hazards of the taxpayer's business (in the event of bankruptcy).

When real estate is owned by a cash method individual and rented to a related accrual method corporation, the individual will recognize rental income as payments are actually or constructively received. Further, the corporation will claim deductions for rental expense as it accrues under Sec. 461, subject to Secs. 267 and 707.

A cash method individual must recognize rental income, although not actually received, when the related accrual method corporation accrues the rental expense on its books, the accrued rent accounts on the books of the corporation are earmarked or set aside for the respective shareholder-creditors, and the taxpayer-lessors have constructively received such income (Fetzer Refrigerator Co., 437 F2d 577 (6th Cir. 1971)).

In Hooper, TC Memo 1995-108, the issue was addressed by the court in the context of a cash method corporation. The individual taxpayer-lessors were paid $3,000 per month rent by their wholly owned cash method lessee corporation from January through May 1989. In June, the corporation decided that no rent would be paid from june through August, and the corporation made no entries or accruals for rental payments for these three months. In August, the taxpayer-lessors contributed the property to the corporation.

On their 1989 tax return, the taxpayer-lessors reported $15,000 in rental income from January through May. The IRS issued a deficiency notice for tax on rental income for june through August. The Tax Court sustained the Service's...