Tax Consequences of Shareholders’ Rent-Free Use of Corporate Property

The tax consequences of rent-free use of corporate property by shareholders have received little attention from the courts since the 1950s and even less from commentators. The Code and regulations do not provide any specific guidance, but instead rely on general principles of income tax. However, an ostensibly similar type of transaction has received a tremendous amount of attention by courts, commentators and Congress. For a generation the courts struggled to come to grips with the taxation of interest-free loans from corporations to their shareholders. The courts for the most part rejected the analogy between rent-free use of property and interest-free use of money and refused to apply to the latter the principles that had guided them in dealing with the former. When the path they chose proved impassable, Congress provided a legislative solution for the taxation of interest-free loans.The Article analyzes the tax consequences of rent-free use of corporate property by shareholders. It demonstrates that, despite the apparent similarities between rent-free use of property and interest-free use of money, there is an important difference, which can complicate analogizing from one to the other: what are purportedly loan proceeds can be bifurcated and recharacterized whereas rent-free use of property cannot. Interestingly, this difference played no part in the development of the case law. The supposed difference, upon which the courts relied when refusing to apply to interest-free loans the case law as it had developed with regard to rent-free use of property – namely, that the shareholder may deduct interest but not rent – is illusory.The most surprising conclusion arrived at is that the economic benefit inherent in the rent-free use of corporate property, while constituting gross income in the hands of the shareholders, is not a “distribution.” Thus, earnings and profits of the lending corporation are irrelevant in determining the tax consequences. Furthermore, the rent-value will be taxed at full ordinary rates and not at the reduced rate applicable to dividends.The Article traces the development of the case law regarding the taxation of interest-free loans from 1940 through and the legislative solution eventually provided by Congress with the addition of section 7872 to the Code. It shows that the legislative solution to the problem of interest-free loans is inapplicable to rent-free use of property, not only because of its language but, more importantly, because section 7872 relies on that particular feature of interest-free use of money that distinguished it from the rent-free use of property. It analyzes the taxation of rent free use of corporate property in light of the issues that caused the courts such difficulties when they confronted the problem of interest-free loans. Finally, it compares the tax consequences of rent free use of corporate property with those of an economically equivalent transaction in which the corporation rents property to its shareholders and then distributes as a dividend the rent received. The Article contends that the discrepancy in the relative tax burdens, far from undermining the analysis, actually supports its soundness, as demonstrated by a comparison non-integrated, partially integrated and fully integrated corporate tax systems.