My commercial lease bundles rent for the building together with rent for furniture, fixtures, and equipment -- can the Department override the allocation stated in my lease agreement and tax a bigger share of my rent?

Plain-English summary

When a single lease covers both real property (the building or space itself) and tangible personal property (furniture, fixtures, equipment), only the personal-property portion of the rent is subject to Virginia sales tax -- the real property portion isn't taxable at all. This ruling is a clean example of how that split gets determined: by the lease document itself, not by an auditor's own estimate.

A restaurant and hotel was audited for sales and use tax compliance, and the auditor concluded that its rental payments had been improperly allocated between real property and furniture, fixtures, and equipment (FF&E) -- the auditor then adjusted the allocation to a flat 50% real property / 50% FF&E split, which increased the taxable share of the rent. The taxpayer appealed, arguing that the actual lease agreement supported a different, and more favorable, allocation.

The Department explained the underlying rule: Virginia Code § 58.1-603 taxes the lease or rental of tangible personal property, but leasing real property (and fixtures attached to it) is not subject to sales tax (citing P.D. 95-223). Where a single lease bundles both, the lessor has to provide a breakdown between the value of the personal property and the value of the real property in the lease -- and if no such breakdown exists and there's no other evidence, the tax applies to the ENTIRE lease payment (citing P.D. 93-188), which is a real risk for a taxpayer that can't document an allocation at all.

Here, though, the taxpayer had documentation: an executed lease agreement with an exhibit laying out the total value of the tangible personal property covered by the lease, allocating rental payments 90% to real estate and 10% to FF&E, plus additional schedules supporting that same allocation. Because the Department's long-standing policy is that the underlying lease document governs the tax treatment of the transaction, the Department sent the audit back to the auditor to adjust the tax on the monthly lease payments to match the lease's actual 90/10 allocation, rather than the auditor's flat 50/50 estimate.

What this means for you

Any business leasing space that includes both real property and furniture, fixtures, or equipment

Get -- and keep -- a lease agreement (or an exhibit/schedule to it) that clearly breaks out the value of the tangible personal property included in the lease, separate from the real property. That documented allocation is what controls the sales tax treatment, not a flat percentage an auditor might otherwise apply.

Businesses without a documented allocation in their lease

If your lease bundles real and personal property rent with no breakdown, and you can't produce other evidence of the actual split, the ENTIRE lease payment can become taxable -- not just the personal property portion. Don't wait for an audit to figure out the allocation; document it in the lease itself.

Lessors negotiating combined real-property/FF&E leases

Building a clear, itemized allocation into the lease document (and keeping supporting schedules) protects both you and your tenant from having an auditor impose its own less favorable split later.

Common questions

Q: My lease covers both my building space and the furniture/equipment in it -- is the whole rent taxable?
A: No -- only the tangible personal property (furniture, fixtures, equipment) portion of the rent is subject to Virginia sales tax. The real property portion is not taxable.

Q: How is the taxable portion determined if my lease bundles both into one payment?
A: By the allocation documented in the lease agreement itself (an exhibit or schedule breaking out the personal property value). The Department's policy is that the underlying lease document governs the tax treatment.

Q: What happens if my lease doesn't specify any allocation between real and personal property?
A: If there's no breakdown in the lease and no other evidence of the actual split, the tax can apply to the ENTIRE lease payment -- not just the equipment portion.

Q: An auditor applied a flat percentage split to my lease payments that doesn't match my actual lease terms -- can I appeal that?
A: Yes -- as this ruling shows, if you can produce your executed lease agreement (and supporting schedules) documenting a different allocation, the Department will apply the lease's actual terms rather than the auditor's estimate.

Citations and references

• Va. Code § 58.1-603 (imposes sales tax on every person who sells, leases, or rents tangible personal property in Virginia)
• Va. Code § 58.1-602 (defines "sale" to include lease or rental of tangible personal property; defines "lease or rental")
• P.D. 95-223 (8/29/1995) (lease of real property and attached fixtures is not subject to sales tax; only the personal property portion of a combined lease is taxable)
• P.D. 93-188 (8/26/1993) (absent a documented breakdown between real and personal property values in a combined lease, tax applies to the entire lease payment)

Subject

Retail Sales and Use Tax: Lease - Combined Real and Tangible Personal Property

Source

• Landing page: Virginia Laws, Rules & Decisions
• Ruling: P.D. 22-72

Original ruling text

April 13, 2022

Re: § 58.1-1821 Application: Retail Sales and Use Tax

Dear *,

This is in response to your letter in which you appeal the retail sales and use tax assessment issued to * (the Taxpayer) as a result of an audit for the periods from May 2015 through April 2018. I apologize for the delay in responding to your letter.

FACTS

The Taxpayer, a restaurant and hotel in Virginia was audited for sales and use tax compliance. During their examination, the auditor concluded the Taxpayer’s rental payments were being improperly allocated between the real estate and the furniture, fixtures and equipment and adjusted the allocation to 50% real property and 50% tangible personal property. The Taxpayer appeals, contending the property allocation is proper and is supported by the terms of the lease agreement.

DETERMINATION

Virginia Code § 58.1-603 imposes the sales tax on every person who sells or leases or rents tangible personal property in the Commonwealth. Virginia Code § 58.1-602 defines the term “sale” to mean “any transfer of title or possession, or both, exchange, barter, lease or rental, conditional or otherwise, in any manner or by any means whatsoever, of tangible personal property…” This same section also provides that the term “lease or rental” “means the leasing or renting of tangible personal property and the possession or use thereof by the lessee or renter for a consideration, without transfer of the title to such property.”

While the lease of real property and figures attached thereto is not subject to the sales tax, the lease of the tangible personal property included in the lease is subject to the tax. See Public Document (P.D.) 95-223 (8/29/1995). Accordingly, the lessor must provide a breakdown of the value of tangible personal property versus the value of the real property included in the lease. If the lessor is not able to provide such a breakdown and no other evidence is available, the tax will apply to the entire lease payment. See P.D. 93-188 (8/26/1993).

In this instance, the Taxpayer has provided an executed lease agreement, which includes an exhibit, which lays out the total value of the tangible personal property included in the lease. According to this exhibit B rental payments are to be allocated 90% to real estate and 10% to furniture, fixtures and equipment. Additional schedules provided by the Taxpayer support the allocation in the lease agreement.

As indicated above, the Department’s long-standing policy is that the underlying document governs the treatment of the transaction for sales and use tax purposes. Therefore, the audit will be returned to the auditor to adjust the tax attributable to the monthly lease payment, pursuant to the terms of the lease agreement. The Taxpayer will receive an adjusted assessment and a revised bill will be issued for any outstanding liability, which should be paid within 60 days to avoid the accrual of additional interest charges.

The Code of Virginia sections and public documents cited are available online at www.tax.virginia.gov in the Laws, Rules, and Decisions section of the Department’s website. If you have any questions about this determination, you may contact * in the Office of Tax Policy, Appeals and Rulings, at ***.

Sincerely,

Craig M. Burns

Tax Commissioner

AR/1976.A

Related Documents

95-223

93-188