ASC 842 Lease Accounting Tax Impacts: Book-Tax Differences and Deferred Taxes

The new lease accounting standard, ASC 842, was issued by the FASB in early 2016. Many public companies have already adopted the standard and ASC 842 lease accounting software. And private companies soon to follow. However, adoption or initial compliance with ASC 842 is just the first step.

Beyond initial implementation, organizations must evaluate the tax accounting for leases, including how right-of-use (ROU) assets and lease liabilities create book-tax differences, deferred tax assets, and deferred tax liabilities. One of the most common “Day 2” challenges is understanding the tax impact of ASC 842 lease accounting on federal income tax reporting.

How ASC 842 Impacts Tax Accounting for Leases

While ASC 842 significantly changes balance sheet presentation for operating leases, tax accounting for leases has not changed. For tax purposes, leases continue to be evaluated under existing federal income tax rules to determine whether a lease is treated as a true lease or a financing arrangement.

The disconnect between financial reporting under ASC 842 and tax treatment is what drives many of the ASC 842 tax considerations companies now face. The recognition of ROU assets and lease liabilities for book purposes introduces new temporary differences between book and tax bases, even though taxable income calculations may remain unchanged.

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Classification for tax treatment under ASC 842

For tax purposes a lease can be classified as a true lease or as a sale (financing) on financial statements. Tests are involved to determine which party carries the benefits and burdens of ownership. The tests for tax treatment are largely based on case law, depend on the substance of the transaction, and are similar but not identical to the finance vs operating tests in ASC 842 and IFRS 16.

Because tax classification and book classification are determined independently, the same lease may be treated differently for financial reporting and tax purposes, creating ongoing compliance and reporting complexity.

Even after a lease is classified for tax purposes, the downstream treatment can differ based on how the arrangement is structured and how costs are recognized for book versus tax. The categories below summarize the most common tax-treatment outcomes and where ASC 842 lease accounting tax impacts tend to show up in reporting, reconciliation, and deferred tax tracking.

True lease (tax rental treatment)

Lease payments are generally deductible as rent under the agreement’s payment pattern, and the lessee does not claim depreciation on the underlying asset.

Financing / conditional sale (non-tax lease)

The lessee is treated as the tax owner and typically deducts depreciation and interest rather than rent, which can diverge sharply from ASC 842 book presentation.

Timing differences (deferred rent and similar items)

ASC 842 changes how lease cost is recognized for book purposes, so differences between cash payments and book expense often still create timing differences—even when “deferred rent” is no longer a prominent book account.

Lease incentives (TIAs, abatements, reimbursements)

Tax treatment depends on the facts (e.g., who owns the improvements, form of incentive, and lease terms). Under ASC 842, incentives often reduce the ROU asset or affect lease cost, so the same incentive may land differently for tax versus book.

Deferred taxes from ROU assets and lease liabilities

Because ROU assets and lease liabilities are recorded for book but may have little or no tax basis, companies often need to recognize and track deferred tax assets/liabilities as temporary differences reverse over the lease term.

Interest presentation vs. interest deductibility

ASC 842 can create “interest-like” expense (especially for finance leases), but many tax leases don’t generate a separate interest deduction—so provision and return work may require reclassification and clear book-to-tax support.

Book-tax differences under ASC 842

Classification determinations can certainly put GAAP books and tax books out of sync, but other items can also generate book-tax differences. For example: Tenant Improvement Allowances (TIA) received up front are recorded as an offset to the ROU Asset under ASC 842, which, for an operating lease, has the effect of reducing the level rent expense over the term of the lease.

However, for tax, TIA’s need to undergo a further test regarding which party owns and funds the improvement. Then, a determination can be made regarding the impact to the lessee’s income and deductible expenses, which may or may not correspond to the book treatment under ASC 842. Other items that may generate differences include impairment scenarios, free rent periods, direct costs, asset retirement obligations, and embedded leases.

Deferred tax assets and liabilities

ROU asset and lease liability accounts are being added to the balance sheet for the first time for book purposes. The book and tax basis for the associated leases will need to be tracked going forward to calculate and record ASC 842 deferred tax assets and deferred tax liabilities accurately.

Ongoing monitoring is essential, particularly when leases are modified, impaired, or terminated.

ASC 842 Deferred Tax Example: ROU Assets and Lease Liabilities

Under ASC 842, lessees recognize both an ROU asset and a lease liability for operating leases on the balance sheet. For tax purposes, however, these balances generally do not exist. As a result, companies must track differences between the book basis and tax basis of lease-related accounts.

For example, if a company recognizes higher lease expense for book purposes in the early years of a lease due to ROU asset amortization, but deducts rent evenly for tax purposes, a deferred tax asset or liability may arise. These differences reverse over the life of the lease and must be monitored to ensure accurate tax provision and financial reporting.

Next steps for ASC 842 tax considerations

Companies should involve tax resources early when planning for ASC 842 compliance and ongoing lease management. Understanding how lease classification, book-tax differences, and deferred taxes interact can help reduce audit risk and improve reporting accuracy.

Organizations should also work with an ASC 842 lease accounting software provider that supports book and tax reporting, historical tracking, and expert guidance across the full lease lifecycle.