What Is a Common Control Lease? ASC 842 and IRC 482 Rules

A common control lease is a lease of property or equipment between two businesses that are owned or controlled by the same person or group. Because the same people sit on both sides of the deal, rent and other terms often reflect internal goals rather than market forces, and that is exactly why U.S. GAAP and the IRS impose specific rules on how these arrangements are documented, priced, and reported.

When Two Entities Are Under Common Control

Two entities fall under common control when the same person or group can direct both. The most widely referenced test comes from SEC staff observations, which the FASB has pointed to as a starting point. Under those observations, common control exists when:

A single individual or business holds more than 50 percent of the voting ownership in each entity.
Immediate family members (a married couple and their children) collectively hold more than 50 percent of the voting ownership in each entity, with no evidence they would vote differently.
A group of shareholders holds more than 50 percent of each entity’s voting ownership and has a written agreement to vote their shares together.

FASB did not create its own standalone definition in ASU 2023-01, but noted that private companies and most nonprofits may apply a broader interpretation.¹

For tax purposes, the IRS looks past who is listed on the stock certificate. Under IRC Section 318, you can be treated as owning shares that belong to your spouse, parents, children, or grandchildren, and stock held by a partnership, trust, or corporation can be attributed proportionately to its partners, beneficiaries, or shareholders. Even holding an option to buy stock counts as owning it. Two businesses can therefore be commonly controlled for tax purposes even when no single person directly holds a majority stake in both.

Why the Rules Are Different

In an ordinary commercial lease, landlord and tenant negotiate at arm’s length, each trying to get the best deal. A common control lease lacks that tension. The same person controls both sides, so rent can be set above or below market to serve a broader business strategy. Setting rent too high or too low shifts taxable income between the two entities, and that is what draws IRS attention. Lease duration, renewal options, and termination clauses in these arrangements also tend to be looser than what unrelated parties would accept, because the “landlord” has no reason to build in protections against a tenant they already control.

Accounting Under ASC 842

Under U.S. GAAP, the general rule for related-party leases is to classify them based on the legally enforceable terms of the deal, using the same criteria you would apply to any other lease. In each entity’s separate financial statements, the accounting should mirror what would happen between unrelated companies. The critical phrase is “legally enforceable.” Written terms that no court would uphold do not count under the baseline approach.

The Practical Expedient for Private Companies

Many private companies operating under common control do not have formal, legally binding lease agreements between their entities. The owner handshakes with herself, figuratively, and everyone just knows the deal. Under the default ASC 842 rules, that informality is a real problem, because there may be no legally enforceable terms to evaluate.

ASU 2023-01 addressed this with a practical expedient available to private companies and nonprofits that are not conduit bond obligors. If you qualify, you can use the written terms of a common control arrangement to determine whether a lease exists and how to classify it, without evaluating whether those terms are legally enforceable.¹

The catch: you need written terms. With nothing in writing, you cannot use the expedient and must fall back on the standard ASC 842 analysis. The election is made arrangement by arrangement, so you can apply the expedient to some common control leases and not others.¹

ASU 2023-01 took effect for fiscal years beginning after December 15, 2023, so it applies to all current reporting periods.

Leasehold Improvements

The leasehold improvement rules in ASU 2023-01 apply to all entities, not just private companies. When a lessee in a common control lease makes improvements to the property, those improvements are amortized over their useful life to the common control group as a whole, not over the lease term. This matters because common control leases often carry short stated terms that get renewed repeatedly. Without this rule, a company that installs a $500,000 HVAC system in a building it leases from a sister company on a five-year lease would have to amortize that improvement over five years, even though everyone involved expects the arrangement to continue for decades.¹

If the lessee stops controlling the use of the underlying asset, any remaining book value of the leasehold improvements is treated as a transfer between entities under common control and recorded as an equity adjustment rather than a gain or loss.¹

The Arm’s-Length Standard Under IRC 482

The IRS has broad authority under IRC Section 482 to reallocate income, deductions, and credits between commonly controlled businesses whenever it decides the existing allocation does not clearly reflect each entity’s income. The statute applies to any two or more organizations, trades, or businesses owned or controlled by the same interests, whether incorporated or not.²

In practice, lease payments between commonly controlled entities need to approximate what unrelated parties would agree to in similar circumstances. IRS regulations call this the arm’s-length standard: a related-party transaction passes muster when the results match what would have happened between strangers dealing on equal footing.³

If you lease a warehouse from a related entity at $2,000 a month when comparable properties in the area rent for $8,000, the IRS can treat the transaction as if the rent were $8,000. That reallocation raises taxable income for the lessee and lowers it for the lessor, potentially creating back taxes, interest, and penalties. Documentation showing how the rent was set and why it reflects market value is the strongest defense against an adjustment.

Disallowed Losses and Timing Under IRC 267

Section 482 is not the only trap. IRC Section 267 creates two more that related parties frequently walk into.

First, losses on the sale or exchange of property between related parties are disallowed. If one commonly controlled entity sells equipment to another at a loss, that loss disappears. The buyer may be able to offset a future gain on the same property by the amount of the disallowed loss, but if the buyer later sells at a loss too, the original disallowed amount is gone permanently. For members of the same controlled group, the loss is deferred rather than permanently disallowed, and it can be recognized when the property leaves the group.⁴

Second, the matching rule catches mismatched accounting methods. If the entity paying rent uses the accrual method and deducts the expense when it is incurred, but the entity receiving rent uses the cash method and does not report the income until cash arrives, Section 267 forces the payer to delay its deduction until the payee actually includes the amount in income. This blocks a timing game where one entity claims a deduction this year while the related entity defers the corresponding income to next year.⁴

For Section 267 purposes, “related parties” include an individual and any corporation or partnership where that individual owns more than 50 percent, two corporations or a corporation and a partnership where the same people own more than 50 percent of each, and various family-member combinations. Section 267 uses its own constructive ownership rules, which differ slightly from Section 318. Siblings count as related under Section 267 but not under Section 318.

Penalties for Mispricing

The consequences of mispricing a common control lease go beyond owing more tax on the reallocated income. IRC Section 6662 adds accuracy-related penalties when the price is far enough off the mark.

A 20 percent penalty applies to the underpayment if the price claimed for the use of property is 200 percent or more, or 50 percent or less, of the correct arm’s-length price, or if the total transfer pricing adjustment for the year exceeds the lesser of $5 million or 10 percent of gross receipts.⁵

The penalty doubles to 40 percent for a gross valuation misstatement, which applies when the claimed price is 400 percent or more, or 25 percent or less, of the correct price, or when the net adjustment exceeds the lesser of $20 million or 20 percent of gross receipts.⁵

These penalties stack on top of the additional tax from the reallocation, plus interest. For a common control lease where the rent is set at a small fraction of market value, the numbers add up quickly. Contemporaneous documentation, including a comparable market analysis of the lease rate, is the most reliable way to keep an adjustment from being triggered in the first place.

1
Financial Accounting Standards Board. Accounting Standards Update 2023-01 – Leases (Topic 842) Common Control Arrangements
2
Office of the Law Revision Counsel. 26 USC 482 – Allocation of Income and Deductions Among Taxpayers
3
Internal Revenue Service. Comparison of the Arm’s Length Standard With Other Valuation Approaches – Inbound
4
Office of the Law Revision Counsel. 26 USC 267 – Losses, Expenses, and Interest With Respect to Transactions Between Related Taxpayers
5
Office of the Law Revision Counsel. 26 USC 6662 – Imposition of Accuracy-Related Penalty