Surprise: Related party rules do not kill prepaid rent strategy

Find out in our 2024 year-end tax strategies for business deduction how to pay 12 months’ rent in advance on December 31 and deduct the full amount this year using IRS safe harbor.

Say you operate your S corporation business on a cash basis and pay fair market rent to your single-member LLC that owns the building you use for the business. Here is what you can do:

- On December 3, 2024, your S corporation cuts a $36,000 rent check for 12 months to your single-member LLC and mails it using certified mail.
- January 3, 2025, you deposit the rental check in your LLC’s bank account.

Result:

You can enjoy a 2024 rent deduction because your S corporation deducts the rent on its 2024 tax return and passes the lower income amount on a Schedule K-1 to your tax return. Your single-member LLC reports the rental income on Schedule E of your 2025 tax return.

What makes this possible?

Check these two rules:

The IRS safe-harbor rule on prepaid expenses
The fact that the related party rules do not apply to the cash basis taxpayers in this scenario.

IRS Safe Harbor

The 12-month rule for prepaid expenses of the IRS states:

A cash-basis taxpayer can deduct prepaid expenses in the year of payment if the right or benefit paid does not extend beyond the earlier of:

- 12 months after the right or benefit begins, or
- The end of the tax year following the year in which the payment is made

You meet both rules. You paid no more than 12 months; your rent payments do not go into 2026.

No related party disallowance

Technical note: Your S corporation and your single-member LLC are related parties. The tax code’s related party rules generally disallow losses and certain transactions between related parties.

In the prepaid rent strategy, the related party rule does not apply because both your solely owned corporation and your single-member LLC are on a cash basis.

The tax code’s related party expense rules apply to mismatches caused by the reason of the method of accounting.

If you, your S corporation, and your LLC use the same accounting method—the cash method—there is no mismatch in the method.

BergerCPAFirst, with over 30+ years of experience, offers comprehensive tax preparation services for individuals and businesses nationwide. Our commitment is to provide personalized attention while ensuring compliance and maximizing tax benefits. If you have any questions or would like to schedule a consultation, please call (201) 587-9200 or send us an inquiry.