Were shareholder distributions taxable rent when a related business occupied real property without a written lease?

Plain-English summary

A related operating company occupied commercial real property owned by a separate related corporation. The parties ended their written lease and stopped labeling payments as rent. Instead, the operating company made annual distributions to its owners, who also owned the property company and planned to contribute funds to it for mortgage, tax, insurance, and other property expenses.

Florida found a landlord-tenant relationship despite the lack of a written lease because one legal person occupied another person's property with permission. It also treated the distributions flowing through the common owners as rental consideration. Part of that money ultimately paid the landlord's property expenses, and the separate-entity structure provided the business benefit of liability segregation.

If the parties could reasonably identify the amount of the property expense obligations, tax applied only to that amount. If they could not, Florida would treat all distributions from the tenant to the two owners as taxable rental consideration.

What this means for you

Ending a written lease or relabeling cash flow does not by itself end a taxable related-party rental arrangement. Florida looked at occupancy, separate legal ownership, indirect payments, the source of funds used for property expenses, and the business benefits of the structure.

Common questions

Can a landlord-tenant relationship exist without a written lease? Yes. The ruling found one because the operating company occupied property owned by another legal person.

Why were shareholder distributions treated as rent? The owners received distributions from the tenant and then funded the landlord's property expenses. Florida treated that indirect flow as rental consideration under the particular facts.

Did the fact that federal tax rules required equal S-corporation distributions change the answer? No. The Department said that requirement did not resolve the Florida sales-tax issue.

How much of the distributions was taxable? The reasonably identifiable amount used for property expense obligations. If the parties could not identify that amount, all of the distributions would be treated as rental consideration.

Did related ownership eliminate tax? No. The ruling states that related-person rentals and direct or indirect consideration were subject to tax under the cited rule.

Citations and references

• Fla. Stat. § 212.031 (tax on renting, leasing, or licensing real property)
• Fla. Stat. § 212.02(2), (12) (business and person definitions)
• Fla. Admin. Code r. 12A-1.070(1), (19) (real-property licenses and related-party consideration)
• Fla. Stat. § 608.471(3) (separate treatment of disregarded entities for non-income-tax purposes)
• Regal Kitchens, Inc. v. Department of Revenue, 641 So. 2d 158 (Fla. 1st DCA 1994)
• Fla. Stat. § 213.22 (Technical Assistance Advisements)

Source

• Landing page: Florida Tax Law Library
• Advisement: TAA 07A-011

Original ruling text

SUMMARY
QUESTIONS: (1) Whether there is a landlord and tenant relationship when there is no
written lease agreement between the person occupying a piece of real property and the
person (a different person) that owns the piece of real property. (2) Whether periodic
distributions made by the occupant of a piece of real property to the related ownership of
the owner of the piece of real property are “rental consideration” subject to Florida sales
tax under Section 212.031, F.S.
ANSWERS: There is a landlord/tenant relationship present because one person is
occupying the real property of another person.
The owners of the piece of real property are “in the business” of renting, as they have
created this business arrangement for specific business benefits (i.e., to insulate the
landlord from the liabilities associated with the tenant).
The money (distributions) flowing from the tenant to landlord (via the natural persons) is
rental consideration because part of the money (distributions) will ultimately be used to
satisfy the property’s expense obligations.
If the parties can reasonably identify the amount of the property’s expense obligations,
then Florida sales tax would only be due on the amount equal to the property’s expense
obligations. Otherwise, the Department will view all of the distributions flowing from the
tenant to the natural persons as rental consideration subject to Florida sales tax under
Section 212.031, F.S.

April 11, 2007

Re:

Technical Assistance Advisement 07A-011
Florida Sales and Use Tax
XXX
Sections 212.02, 212.031, 213.22, and 608.471, F.S. (“Florida Statutes”)
Rule 12A-1.070, F.A.C. (“Florida Administrative Code”)
XXX, Inc. (alternatively “Taxpayer” and “XXX”)
Related Party Real Property Rentals – Identifying Taxable Rent Consideration

Dear :
This response is in reply to your letters dated July 22, 2005 and September 23, 2005,
requesting the Department’s issuance of a Technical Assistance Advisement (“TAA”)
pursuant to Section 213.22, F.S., and Chapter 12-11, F.A.C., regarding related entities
and the rental of commercial real property. An examination of your letters has established

that you have complied with the statutory and regulatory requirements for issuance of a
TAA. Therefore, the Department is hereby granting your request for issuance of a TAA.
Along with your letter of September 23, 2005, you provided the following documents:
(1) Year 2004 Federal Income Tax Returns for both the Taxpayer and the owner of the
property in question; (2) documents related to the mortgage loan on the property in
question; (3) Assignment of Rents and Leases between the owner of the property and the
mortgagee and correspondence from the mortgagee; (4) Articles of Incorporation for both
the Taxpayer and the owner of the property in question; (5) Promissory Note related to
the property; (6) Previous Lease Agreement (now null and void) between the Taxpayer
and the owner of the property; (7) Secretary of State filings for both the Taxpayer and the
owner of the property; (8) Shareholder Agreements for the owner of the property; and (9)
Trust documents for both of the relevant Trusts involved in this Request.
ISSUES

1. Whether there is a landlord and tenant relationship when there is no written lease
   agreement between the person occupying a piece of real property and the person (a
   different person) that owns that piece of real property.
2. Whether periodic distributions made by the occupant of a piece of XXX to the related
   ownership of the owner of the piece of XXX are “rental consideration” subject to Florida
   sales tax under Section 212.031, F.S.
   FACTS
   Your letter of July 22, 2005, provides, in part:

[“Tenant”] … is an S-Corporation that is in the business of selling and
distributing electronic equipment, parts and accessories to wholesalers and
retailers. [Tenant] uses and occupies real property owned by [“Landlord”] … a
related entity.
[Tenant] is owned ultimately 100% by [“the two sons”]. [The two sons] each
currently own 25.25% of [Tenant] and the remaining 49.50% is held in a trust,
[“The Annuity Trust”], with reversion in equal shares upon the death of [the
settlor, “Father”] or expiration of [the] trust on December 30, 2008, whichever
occurs earlier, to [the two sons], jointly as trustees via the [“Family Trust”]. [The
two sons] ultimately receive the 49.50% ownership interest in [Tenant] held in the
[Annuity Trust] as detailed by various provisions of the Family Trust.
[Landlord], a Florida S Corporation, is 100% owned by [the two sons] in equal
shares.

[Tenant] operates its business from real property owned by [Landlord] at
[“Property” located within a Florida city]. In 1994, [the two sons] created
[Landlord] and purchased said real property for the use and occupancy of
[Tenant], their business venture. The main business purpose of using a separate
legal entity to purchase the real property was to segregate liability that may arise
from the use of said real property from the business. In addition, [Tenant] is the
guarantor of said real property’s underlying mortgage.
Prior to July 15, 2005, [Tenant] had a lease arrangement with [Landlord] wherein
[Tenant] would remit monies to [Landlord] on a monthly basis due the first of the
month and [Landlord] would collect and remit sales tax to the Florida Department
of Revenue (“DOR”) on the basis of such lease payments. The annual rent per
lease agreement is approximately $238,000. As of July 15, 2005, however,
[Tenant] severed the existing lessor-lessee relationship with [Landlord] and will
discontinue remitting monies to [Landlord] for use and occupancy of said real
[property] thereafter. [Landlord], as owner of the real estate, remains responsible
for maintenance, real estate taxes, insurance, debt service and other expenses
related to the operation of the real estate. Effective July 15, 2005, there is no
written or unwritten lease agreement between [Tenant] and [Landlord] regarding
the use of the real property.
The [Annuity Trust] requires an annual distribution of 11% of the original net fair
market value of the trust property which is defined as 49.50% of shares of
common stock of [Tenant]. As a result, [Annuity Trust] has received a distribution
of approximately $250,000 per annum. Due to this mandatory distribution and the
rules regarding equal per value share distributions to S-Corp. shareholders, [the
two sons] also receive distributions from [Tenant] of approximately $250,000 per
annum.
Beginning in August, 2005, [the two sons], as owners of [Landlord], will make
capital contributions to [Landlord] to satisfy expenses (i.e., mortgage, interest,
property taxes and insurance) related to the subject real property. [The two sons]
will receive approximately $250,000 in distributions from [Tenant] as noted
above that is in excess of the previous annual rent of $238,000. Such distributions
from [Tenant] do not coincide with the capital contributions made by [Landlord’s]
owners to satisfy expenses related to the property.
In addition, for federal income tax purposes, [Landlord] will no longer indicate
the receipt of rental payments related to the use of the property by [Tenant] on its
federal corporate return (i.e., 1120S). Nor will [Tenant] indicate the payment of
rent for the use of the property for federal income tax purposes on its federal
corporate return (i.e., 1120S). Moreover, for financial accounting purposes,
neither [Landlord] nor [Tenant] will indicate the receipt or payment of rental
payments related to the use of the property by [Tenant] on any financial or
accounting records maintained by either entity.

***
Article III of the Annuity Trust, provides, in part:
The trust estate subject to this Agreement shall be held, administered and
distributed by the Trustee, upon the following terms and conditions:
1.(a) Until ten (10) years after the date of this Agreement [December 30, 1998] or
the earlier death of the Settlor (the “trust term”), the Trustee shall in each taxable
year of the Trust pay to or for the benefit of the Settlor an amount (the “annuity
amount”) equal to eleven (11%) percent of the original net fair market value of
the trust property …. The annuity amount shall be paid from net income, and, to
the extent net income is not sufficient, from principal, in equal quarterly
installments, on the last day of March, June, September and December ….

A review of Landlord’s 2004 Federal Income Tax return provides the following
information: (1) it received $239,676 in “gross rents” on the property; (2) it identified
$147,369 in expenses for the property; and (3) it divided the “net income” equally
between the two sons.
During our telephone conversation of December 7, 2005, you advised that the payment
made by Tenant to the Annuity Trust must be made regardless if Tenant shows a profit
for that particular year.
TAXPAYER’S POSITION
Your letter of July 22, 2005, also provides, in part:

It is conceded that a taxable rental relationship had previously existed between
[Tenant] and [Landlord]. [Tenant] and [Landlord] were parties to a lease wherein
[Tenant] made lease payments to [Landlord]. As of July 15, 2005, however, such
relationship was severed and there is no further “rental consideration” flowing
from [Tenant] to [Landlord], either directly or indirectly. [Tenant] continues to
operate their business out of the real estate owned by [Landlord] but [Tenant]
does not make any payments to [Landlord] for the use of such real estate.
Therefore, the requisite consideration and rental relationship subject to sales tax is
lacking in the present circumstance.

Your letter also cites to the cases of St. Johns Trading Company v. Department of
Revenue, DOAH Case Number 84-1652 (1985) and Department of Revenue v. Ryder
System, Inc., 406 So.2d 1299 (Fla. 1st DCA, 1981) and to three (3) Technical Assistance
Advisements.

During our telephone conversation of December 7, 2005, you provided that Treasury
Regulations require that the two sons receive the same distribution as the Annuity Trust.
In support of that assertion, you provided me with an excerpt from “The S Corporation
Answer Book” (Sixth Edition, Sydney S. Traum and Judith Rood Traum, Aspen
Publishers), which discusses the relevant Treasury Regulations.
APPLICABLE STATUTES AND RULES
Section 212.02, F.S., provides in part:

(2) "Business" means any activity engaged in by any person, or caused to be
engaged in by him or her, with the object of private or public gain, benefit, or
advantage, either direct or indirect. …

(12) "Person" includes any individual, firm, copartnership, joint adventure,
association, corporation, estate, trust, business trust, receiver, syndicate, or other
group or combination acting as a unit and also includes any political subdivision,
municipality, state agency, bureau, or department and includes the plural as well
as the singular number.

Section 212.031, F.S., provides in part:
(1)(a) It is declared to be the legislative intent that every person is exercising a
taxable privilege who engages in the business of renting, leasing, letting, or
granting a license for the use of any real property ….

(c) For the exercise of such privilege, a tax is levied in an amount equal to 6
percent of and on the total rent or license fee charged for such real property by the
person charging or collecting the rental or license fee. The total rent or license fee
charged for such real property shall include payments for the granting of a
privilege to use or occupy real property for any purpose and shall include base
rent, percentage rents, or similar charges. …

(3) The tax imposed by this section shall be in addition to the total amount of the
rental or license fee, shall be charged by the lessor or person receiving the rent or
payment in and by a rental or license fee arrangement with the lessee or person
paying the rental or license fee, and shall be due and payable at the time of the

receipt of such rental or license fee payment by the lessor or other person who
receives the rental or payment. …

Section 213.22(1), F.S., provides in part:
… Technical assistance advisements shall have no precedential value except to
the taxpayer who requests the advisement and then only for the specific
transaction addressed in the technical assistance advisement, unless specifically
stated otherwise in the advisement. …
Section 608.471, F.S., provides in part:

(3) Single-member limited liability companies and other entities that are
disregarded for federal income tax purposes must be treated as separate legal
entities for all non-income-tax purposes. …
Rule 12A-1.070, F.A.C., provides in part:
(1)(a) Every person who rents or leases any real property or who grants a license
to use, occupy, or enter upon any real property is exercising a taxable privilege
….

(19)(a) The lease or rental of real property or a license fee arrangement to use or
occupy real property between related "persons," as defined in s. 212.02(12), F.S.,
in the capacity of lessor/lessee, is subject to tax.
(b) The total consideration, whether direct or indirect, payments or credits, or
other consideration in kind, furnished by the lessee to the lessor is subject to tax
despite any relationship between the lessor and the lessee.
(c) The total consideration furnished by the lessee to a related lessor for the
occupation of real property or the use or entitlement to the use of real property
owned by the related lessor is subject to tax, even though the amount of the
consideration is equal to the amount of the consideration legally necessary to
amortize a debt owned by the related lessor and secured by the real property
occupied, or used, and even though the consideration is ultimately used to pay
that debt.

DISCUSSION

The advisement sought actually addresses two (2) issues. The first issue is whether there
exists a landlord/tenant relationship wherein there is no written lease agreement between
the person occupying the property and the person owning the property. The second issue
is whether periodic distributions made by the person occupying the property to the
owners of the person owning the property are “rent consideration” subject to Florida sales
tax under Section 212.031, F.S.
The terms “landlord,” “tenant” and “landlord/tenant relationship” are not defined in
Chapter 212, F.S. However, Black’s Law Dictionary defines “landlord and tenant
relationship” as follows:
… The relationship exists where one person occupies premises of another in
subordination to other’s title or rights and with his permission or consent. Black’s
Law Dictionary 790 (5th ed. 1979).
It has been held that there need not be a written lease in order for there to be a
landlord/tenant relationship. See Regal Kitchens, Inc. v. Department of Revenue, 641
So.2d 158 (Fla. 1st DCA, 1994).
It can be seen that a landlord and tenant relationship does exist under the facts presented.
Here, Tenant (a “person” in its own right) occupies the property of another “person” (i.e.,
Landlord). The next issue (the issue of whether there is taxable rental consideration
flowing between Tenant and Landlord) is much more complicated.
Generally speaking, in Florida, the renting, leasing, letting, or the granting of a license for
the use of any real property is subject to Florida sales tax. See Section 212.031, F.S. Sales
tax is due on the rental consideration paid for the right to use or occupy commercial real
property. See Rule 12A-1.070, F.A.C. The total consideration, whether direct or indirect,
furnished by a lessee to the lessor, is subject to Florida sales tax. See Rule 12A1.070(19)(b), F.A.C., and Seaboard Coastline Railroad Company v. Askew, #72-15 (Fla.
Cir. Ct., 2nd Cir., Leon Co., 1972). (Rent consideration may be payable directly to the
lessor or to some other person directed by the lessor.)
The lease or rental of real property between related “persons” is taxable. See Rule12A1.070(19), F.A.C. “Person” is defined at Section 212.02(12), F.S., and includes all types
of entities including individuals and corporations. Further, limited liability companies
that are disregarded for federal income tax purposes are treated as separate legal entities
for all non-income tax purposes under Florida law. See Section 608.471(3), F.S.
When a business decision is made to create separate legal entities for purposes of owning
and occupying real property to achieve advantages such as preferred financing, tax
advantage, risk control, insurance coverage, or the like, the formalities of such
arrangements are recognized for purposes of imposing Florida sales tax on transactions
between those separate legal entities. See Seaboard Coastline Railroad Company, supra.
Courts have held that parties are not free to “… disavow the existence of the corporation
for the purpose of obtaining a tax advantage.” Regal Kitchens, 641 So.2d at 163. The

Regal Kitchens opinion also held that: “Those who seek the protection afforded by
incorporation must also accept the burdens.” Id.
Your letter cites to two (2) cases (St. John’s Trading Company and Ryder System, Inc.)
which, unfortunately, are of no assistance. St. John’s Trading Company involved the
issue of whether or not the taxpayer’s business practice of recording journal entries as
“rent” exposed it to Florida sales tax. The Hearing Officer found Florida sales tax was
not due because there was no actual transfer of funds (related to the journal entries
labeled “rent”) made between the taxpayer’s stores and their owner. In Ryder System,
Inc., the First District Court of Appeal upheld the trial court’s finding that there was no
landlord and tenant relationship. In it’s per curiam decision, the First District Court of
Appeal did not provide any facts:
The trial court's order was based upon a finding that rent was paid. In this case,
the court below found no landlord and tenant relationship and that Ryder Systems,
Inc. was not engaged in the business of renting, leasing or letting any real
property. Since there was no finding a rental payment was made, the trial court
correctly disapproved the tax. The judgment below is, therefore, affirmed.
Department of Revenue v. Ryder System, Inc., 406 So.2d 1299 (Fla. 1st DCA,
1981).
The holdings of St. John’s Trading Company and Ryder System, Inc. do not assist us
because: (1) there are funds flowing between Tenant and Landlord, via the two sons; and
(2) there is a landlord and tenant relationship because Tenant is occupying the property of
Landlord.
Your letter, our telephone conversations, and the literature you have provided, assert that
the IRC and the Treasury Regulations require that the two sons receive the same
distribution as the Annuity Trust. Basically, in order to qualify as a “small business
corporation,” the corporation must only have one class of stock. If one shareholder
receives a distribution pursuant to a “governing provision” (which the Annuity Trust
document appears to be), then all shareholders must receive the same distribution in order
to avoid having more than one class of stock. See Treasury Regulations Section 1.13611(l)as in “letter” and (2). The fact that the shareholders (the two sons and the
Annuity Trust) are receiving similar distributions in order to comply with Federal Income
Tax regulations does not assist us in answering the issue before us.
Technical assistance advisements have no precedential value except to the taxpayer who
requests the advisement and then only for the specific transaction addressed in the
technical assistance advisement, unless specifically stated otherwise in the advisement.
See Section 213.22(1), F.S.
The Department has previously recognized that there may be situations wherein
“income” or “profit” flowing between related entities would not be “rental
consideration.” The Department has previously advised that it would require a review of
all relevant and controlling documents involved with the transaction and relationship

presented. The Department is interested in the timing, amount and control of the
distributive shares of earnings or cash flow between the parties involved. The
Department looks to all of the relevant and controlling documents to ascertain: (1) that
distributions do not coincide with the time at which the property’s expense obligations
are due; (2) the amount of distributions does not coincide with the amount of the
property’s expense obligations; and (3) the distributions are based on a true reflection of
income or profit and not on the amount of the property’s expense obligations.
The Department has also previously recognized there may be some situations wherein the
true substance of a distribution is to pay property expenses on behalf of the owner of the
property. In those situations, the distribution is subject to Florida sales tax because the
distribution is merely another form of rent consideration.
The Department has viewed a subsidiary's payment of dividends to its sole
shareholder/lessor to be a form of rent consideration paid for the use of the building it
occupied.
The Department also recognizes that taxpayers are free, under the Internal Revenue Code
(“IRC”), Treasury Regulations, and accounting principles, to recharacterize things such
as “rent.” However, for Florida sales tax purposes, and specifically for what has become
known as “related party rentals,” the Department views such recharacterizations with
great skepticism.
While the Department’s previously issued Technical Assistance Advisements are of no
precedential value, we might ask some of the same questions here.
First, do the distributions coincide with the time at which the property’s expense
obligations are due? Your letter provides that they do not.
Second, does the amount of the distributions coincide with the amount of the property’s
expense obligations? We do not know that. We do know that previously paid “rent” was
approximately $239,000 per year and the distributions are approximately $250,000 per
year. We also know that out of the approximately $239,000 in rent received in 2004, the
Landlord claimed approximately $147,000 in expenses and divided the “net income”
between the two sons.
Third, are the distributions based on a true reflection of income or profit and not on the
amount of the property’s expense obligations? We do know that the distributions will be
made regardless of the existence of a profit. It was represented to us that distributions
will be made even if there is a “loss.” We know that the distribution is based on the
language in the Annuity Trust (to wit: “… eleven (11%) percent of the original net fair
market value of the trust property….”)
Fourth, are the distributions made to the tenant’s owner, and if so, will the distributions
be used to pay for the property’s expense obligations? The distributions are made to the
two sons, who, in turn, own Landlord. Your letter provides that the two sons will make

capital contributions to Landlord so that Landlord can satisfy the property expense
obligations.
From these inquires, we can come to some conclusions.
First, there is a landlord and tenant relationship despite there being no written lease
agreement because one person is occupying the real property of another.
Second, the distribution(s) in question, based upon all of the facts and documents
provided, is “rental consideration.” For eleven years, Tenant had been paying Landlord
rent under a lease. While there is a $12,000 difference between the rent paid and the
distribution to the two sons (a difference in favor of the two sons), the amounts are
strikingly similar.
Third, we note that Landlord’s only source of income (per the provided 2004 Federal
Income Tax return) came from rent received on this property. There are no third-party
tenants from which Landlord receives funds possibly sufficient to satisfy the property
expense obligations. The two sons will make capital contributions to Landlord in order
to satisfy the property’s expense obligations. The source of that money will be from the
distributions received by the two sons.
Fourth, the main business purpose of creating a separate legal entity to purchase and hold
title to the real property (i.e., the Landlord) was to segregate liability that may arise from
the use of the real property from the Tenant’s business. The parties here have made a
business decision to organize their relationship(s) in a way to maximize certain
advantages (namely, risk control). This in itself is an economic benefit which indicates
not only a landlord and tenant relationship, but also the existence of “rental
consideration.”
In sum, we can see that, under these particular facts, the distributions made to the two
sons are “rental consideration.” Part of the money flowing from Tenant to the two sons
will be used to pay for the property’s expense obligations (via their contributions);
however, the Department is unable to determine from the facts specifically what those
amounts will be.
CONCLUSION
There is a landlord/tenant relationship present because one person (the Tenant) is
occupying the real property of another person (the Landlord).
The Landlord and the two sons are “in the business” of renting, as they have created this
business arrangement for specific business benefits (i.e., to insulate the Landlord from the
liabilities associated with the Tenant).

The money (distributions) flowing from the Tenant to Landlord (via the two sons) is
rental consideration because part of the money (distributions) will ultimately be used to
satisfy the property’s expense obligations.
If the parties can reasonably identify the amount of the property’s expense obligations,
then Florida sales tax would only be due on the amount equal to the property’s expense
obligation. Otherwise, the Department will view all of the distributions flowing from the
Tenant to the two sons as rental consideration subject to Florida sales tax under Section
212.031, F.S.
This response constitutes a Technical Assistance Advisement under Section 213.22, F.S.,
which is binding on the Department only under the facts and circumstances described in
the request for this advice as specified in Section 213.22, F.S. Our response is predicated
on those facts and the specific situation summarized above. You are advised that
subsequent statutory or administrative rule changes, or judicial interpretations of the
statutes or rules, upon which this advice is based, may subject similar future transactions
to a different treatment than expressed in this response.
You are further advised that this response, your request and related backup documents are
public records under Chapter 119, F.S., and are subject to disclosure to the public under
the conditions of s. 213.22, F.S. Confidential information must be deleted before public
disclosure. In an effort to protect confidentiality, we request you provide the undersigned
with an edited copy of your request for Technical Assistance Advisement, the backup
material and this response, deleting names, addresses and any other details which might
lead to identification of the taxpayer. Your response should be received by the
Department within 15 days of the date of this letter.
Sincerely,
Eric R. Peate
Senior Attorney
Technical Assistance & Dispute Resolution
(850) 922-4714
Control No.: 16932