At the beginning of a lease, it’s not unusual for the lessee to be given free rent for one or more periods, which results in deferred rent under current GAAP lease accounting rules. Instead of free rent periods resulting in zero entries, the accounting approach divides the total amount due over all periods – including the free periods – to reduce the deferred rent liability over the length of the lease. Free rent, also known as deferred rent, should not be confused with early occupancy, which refers to tenants given access to a physical space before the lease term begins.
Deferred rent can also have an impact on income tax under current lease accounting rules, due to the temporary difference between financial statement and the tax returns. Deferred rent is defined as the liability created as a result of the difference between the actual cash paid and the straight-line expense recorded on the financial statements. Typically, the deferred rent recorded is the difference between the straight-line rent recognized for book purposes and the rent deductible for tax purposes. Before the new lease accounting guidelines become effective, a lessee would typically record a deferred tax asset for the deferred rent liability on the books. In addition, initial direct costs (IDC) are capitalized for tax purposes unless they are less then $5,000 (and therefore considered de minimus). Accurately tracking free or deferred rent is one of many tasks needed to perform keep lease accounting running on point. Accounting departments also need to track all the dates and amendments relevant to the lease including the original lease execution date, lease start date, original expiration date, current lease execution date, current possession date and the current expiration date. Feature-rich lease accounting and lease management software can ensure execution of the correct workflow processes and provide efficiencies.