Allowable Rental Costs

We often receive questions regarding the amount of allowable rental costs between related parties. Rental costs are normally allowable to the extent they are reasonable and allocable. In an effort to reduce operating costs, small business owners often purchase a building under a separate entity and lease it back to the government contracting entity at or below market rates. This seems like a reasonable approach. The government incurs the same or similar rental costs as if the contractor leased from an unrelated third party. Sometimes the government incurs less cost because of lower-than-market rental rates. The owner limits certain liabilities by separating the two entities. And, the owner has an opportunity to earn income on the resources employed in ownership of the building.

FAR 31.205-36, however, limits the allowability of rental costs “to the extent they do not exceed the normal costs of ownership.” The normal costs of ownership include depreciation, taxes, insurance, facilities capital cost of money, and maintenance.” As always, interest expense is not allowed. Facilities capital cost of money is way the government allows for an interest-type factor to be included. The Government does recognize that there is a cost to tying up capital, and allows for a limited recovery of that cost.

Let’s walk through a scenario:

  • 30,000 sf building
  • Market rate $7.00/sf + $1.25/sf CAM (common area maintenance)
  • Lease rate $6.00/sf, no CAM
  • Annual rent expense at market rate: $247,500
  • Annual rent expense per lease $180,000
  • Purchased Jan 1, 2014 for $1,850,000
  • Current FMV $2,250,000

Actual expenses

In this scenario of common ownership (related party transaction), the allowable rental costs are $158,811 ($21,189 less than the lease rate). If the contractor claimed rental costs of $180,000 in their incurred cost proposal, those costs would be disallowed and marked as expressly unllowable per FAR 31.2105-36. Expressly unallowable costs are subject to penalty and interest. With DCAA 4 to 6 years behind on incurred cost audits, the contractor could incur several thousand dollars in penalties and interest in addition to the over paid amount of $21,189.

2016 Expense Amount
Depreciation (39 years) $47,436
Taxes $28,000
Insurance $13,500
Fac Cap Cost of Money1 $37,875
Repairs $20,000
Maintenance $12,000
Total $158,811

Facilities Capital Cost of Money

The biggest question in determining the amount of ownership costs is the calculation of facilities capital cost of money. In simplest form, this is the net book value of the asset in question times the allowable interest rate. The interest rate is set semi-annually by the Secretary of the Treasury and published in the Federal Register in December and June of each year for the following six-month period. You can read more about the facilities cost of capital in DCAA’s CAM 8-414.2.

Interest Rates

When calculating the cost of money, you must use rates for the year in question. Use the weighted average for the calendar year, fiscal year, or contract period.

For calendar year 2016, the blended rate is 2.1875% ((2.5% + 1.875%)/2).

For fiscal year 2016 (10/1/2015 – 9/30/2016), the blended rate is  2.3125% ((2.375% x 3/12) + (2.5% x 6/12) + (1.875% x 3/12))

Year Jan – Jun Jul – Dec
2010 3.25% 3.125%
2011 2.625% 2.5%
2012 2.0% 1.75%
2013 1.375% 1.75%
2014 2.125% 2.0%
2015 2.125% 2.375%
2016 2.5% 1.875%

1Cost of Money Calculation

Note that facilities capital cost of money is based on the net book value (purchase price minus depreciation), not purchase price or fair market value. Even though you have $1,850,000 tied up in the building and could sell for $2,250,000, your allowable cost of money decreases over time.

Year Blended Rate Avg Bldg Balance COM $
2014 2.0625% $1,826,282 $37,646
2015 2.25% $1,778,846 $40,024
2016 2.1875% $1,731,410 $37,875

Tips & Tricks

Use our calculator to determine your allowable rental costs.

Consider a property management fee paid to the owner. A portion of rent paid to an unrelated third party is for property management. A company could outsource property management to a real estate company, so paying that fee to the owner of the building may be allowable. Remember to keep it fair and reasonable. In our scenario above, $20,000/year may be a reasonable fee. $100,000/year would certainly be unreasonable.

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January 26th NCMA Webinar: Hot Topics in Unallowable Costs - Left Brain Professionals

[…] •    The annual hat trick: what it is, and what to watch for •    Unallowable vs expressly unallowable costs •    Directly associated unallowable costs •    New FAR 31.205 Selected Cost Principles Guidebook •    Related party rent vs cost of ownership […]

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