Prepaid rent could not be deducted, absent substantial business reason for prepayment.

• Author: Fiore, Nicholas J.

His an attorney and CPA, working as a sole practitioner and using the cash method of accounting. In 1989, he signed a five-year lease for business space, under which he would pay rent monthly. In 1992, H paid the entire rent for 1992,1993 and 1994. (H and his landlord began to negotiate a new lease in 1994 and signed it in 1995.)

On his 1992 return, H deducted the entire rental amount. The IRS allowed the 1992 rent, but disallowed the prepaid rent for 1993 and 1994. In a memorandum decision, the Tax Court (opinion Colvin, J.) held for the Service.

A cash-method taxpayer generally may not deduct prepaid rent in the year paid because it is not an ordinary and necessary business expense for that year. Instead, the taxpayer must deduct prepaid rent ratably over the years in which he uses the property. However, a cash-basis taxpayer may deduct prepaid items when paid, including rent, if he paid the rent (i.e., did not make a mere deposit), had a substantial business reason for making the prepayment in the year it was made and the prepayment did not cause a material distortion in the taxpayer's taxable income in the...