The following discussion covers the rules that apply to the lessor (the owner of the property) and the lessee (the person who rents the property from the owner).

This section does not cover the rules for leasing a passenger automobile. For those rules, see Leasing a Car in Publication 463.

Lessor

The predominant use test (discussed earlier under Applying the Predominant Use Test) and the limits on depreciation for passenger automobiles (discussed later under Special Rule for Passenger Automobiles) generally do not apply to any listed property leased or held for leasing by anyone regularly engaged in the business of leasing listed property.

You are considered regularly engaged in the business of leasing listed property only if you enter into contracts for the leasing of listed property with some frequency over a continuous period of time. This determination is made on the basis of the facts and circumstances in each case and takes into account the nature of your business in its entirety. Occasional or incidental leasing activity is insufficient. For example, if you lease only one passenger automobile during a tax year, you are not regularly engaged in the business of leasing automobiles. An employer who allows an employee to use the employer's property for personal purposes and charges the employee for the use is not regularly engaged in the business of leasing the property used by the employee.

Lessee

A lessee of listed property (other than passenger automobiles) leased after 1986 must include an inclusion amount in gross income for the first tax year the property is not used predominantly in a qualified business use. For information on listed property leased before 1987, see Publication 534.

The inclusion amount for leased listed property is the sum of amount A and amount B.

Amount A. Amount A is the product of the following:

• The fair market value of the property,
  multiplied by
• The business/investment use for the first tax year the business use percentage is 50% or less,
  multiplied by
• The applicable percentage from Table A-19 in Appendix A.

Amount B. Amount B is the product of the following:

• The fair market value of the property,
  multiplied by
• The average of the business/investment use for all tax years the property is leased that precede the first tax year the business use percentage is 50% or less, multiplied by
• The applicable percentage from Table A-20 in Appendix A.

The fair market value is the value on the first day of the lease term. If the capitalized cost of an item of listed property is specified in the lease agreement, the lessee must treat that amount as the fair market value.

The average business/investment use of any listed property is the average business/investment use for the first tax year the business use percentage is 50% or less and all prior tax years the property is leased.

Inclusion Amount Worksheet

The following worksheet is provided to help you figure the inclusion amount for leased listed property.

Inclusion Amount
Worksheet for
Listed Property (Leased)

1.	Fair market value
2.	Business/investment use for first year business use is 50% or less
3.	Multiply line 1 by line 2.
4.	Rate (%) from Table A-19
5.	Multiply line 3 by line 4. This is Amount A.
6.	Fair market value
7.	Average business/investment use for years property leased before the first year business use is 50% or less
8.	Multiply line 6 by line 7
9.	Rate (%) from Table A-20
10.	Multiply line 8 by line 9. This is Amount B.
11.	Add line 5 and line 10. This is your inclusion amount. Enter here and as "Other income" on the form or schedule on which you originally took the deduction (for example, Schedule C or F (Form 1040), Form 1040, Form 1120, etc.)

Example. On February 1, 1998, Larry House, a calendar year taxpayer, leased and placed in service a computer with a fair market value of $3,000. The lease is for a period of five years. Because Larry does not use the computer at a regular business establishment, it is listed property. His qualified business use of the property is 80% in 1998, 60% in 1999, and 40% in 2000. He must add an inclusion amount to gross income for 2000, the first tax year he does not use the computer more than 50% for business. The computer has a 5-year recovery period under both GDS and ADS. Because 2000 is the third tax year of the lease, the applicable percentage from Table A-19 is -19.8%. The applicable percentage from Table A-20 is 22.0%. Larry uses the Inclusion Amount Worksheet for Listed Property (Leased) to figure the amount he must include in income for 2000. His inclusion amount is $224, which is the sum of -$238 (Amount A) and $462 (Amount B).

Inclusion Amount
Worksheet for
Listed Property (Leased)

1.	Fair market value	$3,000
2.	Business/investment use for first year business use is 50% or less	40%
3.	Multiply line 1 by line 2.	1,200
4.	Rate (%) from Table A-19	-19.8%
5.	Multiply line 3 by line 4. This is Amount A.	-238
6.	Fair market value	3,000
7.	Average business/investment use for years property leased before the first year business use is 50% or less	70%
8.	Multiply line 6 by line 7	2,100
9.	Rate (%) from Table A-20	22.0%
10.	Multiply line 8 by line 9. This is Amount B.	462
11.	Add line 5 and line 10. This is your inclusion amount. Enter here and as "Other income" on the form or schedule on which you originally took the deduction (for example, Schedule C or F (Form 1040), Form 1040, Form 1120, etc.)	$224

Special rules. The lessee adds the inclusion amount to gross income in the next tax year if all the following apply.

• The lease term begins within 9 months before the close of the lessee's tax year.
• The lessee does not use the property predominantly in a qualified business use during that portion of the tax year.
• The lease term continues into the lessee's next tax year.

The lessee determines the inclusion amount by taking into account the average of the business/investment use for both tax years and the applicable percentage for the tax year the lease term begins.

If the lease term is less than one year, the amount included in gross income is the amount that bears the same ratio to the additional inclusion amount as the number of days in the lease term bears to 365.

The lease term for listed property other than residential rental or nonresidential real property includes options to renew. You treat two or more successive leases that are part of the same transaction (or a series of related transactions) for the same or substantially similar property as one lease.

Maximum inclusion amount. The inclusion amount cannot be more than the sum of the deductible amounts of rent for the tax year in which the lessee must include the amount in gross income.

Example 1. On August 1, 1999, Julie Rule, a calendar year taxpayer, leased and placed in service an item of listed property. The property is 5-year property with a fair market value of $10,000. Her property has a recovery period of 5 years under the ADS method. The lease is for 5 years. Her qualified business use of the property is 50% in 1999 and 90% in 2000. She pays rent of $3,600 for 2000 of which $3,240 is deductible. She must include $147 in gross income in 2000. The $147 is the sum of Amount A and Amount B. Amount A is $147 ($10,000 x 70% x 2.1%), the product of the fair market value, the average business use for 1999 and 2000, and the applicable percentage for year one from Table A-19. Because the applicable percentage for year one from Table A-20 is 0%, Amount B is zero.

Example 2. On October 1, 1999, John Joyce, a calendar year taxpayer, leased and placed in service an item of listed property that is 3-year property. This property had a fair market value of $15,000 and a recovery period of 5 years under the ADS method. The lease term is 6 months (ending on March 31, 2000) during which he uses the property 45% in business. He must include $71 in gross income in 2000. The $71 is the sum of Amount A and Amount B. Amount A is $71 ($15,000 x 45% x 2.1% x 183/366), the product of the fair market value, the average business use for both years, and the applicable percentage for year one from Table A-19, prorated for the length of the lease. Because the applicable percentage for year one from Table A-20 is 0%, Amount B is zero.

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