How do states tax rentals and leases?

Most states impose a sales tax on rentals and leases for items other than real property under the same laws that they use to impose their sales tax on more traditional purchases. However, due to the nature of how lease payments are made, over the course of multiple months or even years, there are some nuances to how sales tax on rentals operates in each state.

Timing

There are three scenarios for when sales tax will be due on a lease of personal property:

1. The person leasing the property, or the lessor, may be required to pay tax when they purchase the property they are going to lease,
2. The person leasing the property, or the lessee, may be required to pay sales tax on each of their payments for the lease, or
3. The person leasing the property, or the lessee, may be required to pay sales tax on the entire value of the property or the entire amount of the lease upfront.

Though the least common scenario, some states allow businesses that lease property to customers to pay sales tax upfront. Then, because sales tax has already been paid on the property, the businesses are not required to charge their customers sales tax on leases. In Michigan and Arkansas, for example, businesses make a “lessor’s election” every time they purchase property they intend to rent or lease to customers. The business can either choose to purchase the item free of tax using a resale certificate and charge tax on their customer’s lease payments or pay sales tax on their own purchase and not charge tax on leases. In Illinois and Maine, lessors are required to pay the tax upfront, and don’t have the option to charge tax on the lease.

Most commonly, states require businesses that rent or lease to charge their customers sales tax on each payment they make towards their lease or rental, but depending on the terms of the lease, some leases and rentals require the person leasing the property to pay sales tax on their entire purchase upfront. To understand exactly how sales tax applies to a lease, you have to know what type of lease you are dealing with.

Types of Leases and Rentals

Leases of Personal Property can be broadly divided into two categories: Operating Leases and Capital (or Financing) Leases.

An operating lease is generally what you would think of as a “true lease.” Under the terms of your lease or rental, you can use or take possession of property for an amount of time and make regular payments. When you stop making payments, you are required to return the property to the person you rented or leased it from. If you are given the option to purchase the property you are leasing or renting, the sales price is closer to the actual value of the property. In general, operating leases are taxed on each payment towards the lease.

A capital or financing lease is a lease where the terms of the lease or rental agreement give ownership of the property to the lessee in one way or another at the end of the lease. These can be leases that allow you to purchase the property at a heavy discount at the end of a set lease term, or leases that state that you fully own the property after a set number of payments. A common example of this kind of lease is a cell phone plan that includes an additional monthly payment for your device for a set amount of time before allowing you to upgrade to a new phone. Capital leases are generally treated as a normal purchase where you are paying in installments rather than a lease, and often states require that the customer pays the full balance of tax due for the entire lease with the first payment.

Beyond operating and capital leases, there is a third kind of lease that many states don’t treat as either a lease or a traditional sale: a lease or rental of property that includes an operator. If you are renting equipment and the company you are renting it from is also selling you the services of a person to operate the equipment for you, often the rental is considered a service under sales tax laws. For example, in Louisiana, a rental can be considered a nontaxable service if the operator associated with the owner of the property maintains control of it during the rental period, is contracted to complete a specific job with the property, follows standards set up by the owner of the equipment, or if the property cannot be rented without also purchasing the services of the operator.

Leases and Rentals with Special Rules

Long term rentals of buildings or land are almost never subject to sales tax, but short-term rentals of spaces like convention halls, restaurants, or hotel rooms can be subject to either sales tax or a separate accommodations tax. Car rentals, depending on how long they are for, often have their own separate sets of rules entirely. When it comes to leases, “do I have to pay sales tax?” is only the first question you must tackle, but luckily, we can get you started decoding the rest.