Facility Lease Allocation — Splitting Rent Between §280E-Deductible (Cultivation) and Non-Deductible (Retail)
Allocating facility rent between COGS (cultivation space — deductible) and SG&A (retail/office space — non-deductible under §280E) for a vertically integrated cannabis company.
| Account Name | Type | Debit ($) | Credit ($) |
|---|---|---|---|
| Cannabis Inventory — WIP (Cultivation Rent Capitalized: 4,000 SF/10,000 SF × $50K) | Asset (+) | 20,000.00 | - |
| SG&A — Retail/Admin Rent (§280E Non-Deductible: 6,000 SF/10,000 SF × $50K) | Expense (+) | 30,000.00 | - |
| Rent Payable / Cash (Total Monthly Rent) | Liability (+) / Asset (-) | - | 50,000.00 |
💡 Accountant's Note
For a vertically integrated cannabis company operating in a single facility (cultivate, process, and sell from the same building), the monthly rent must be ALLOCATED between: (1) CULTIVATION/PROCESSING SPACE: this portion is a production cost → capitalized into inventory under §471 → flows to COGS when product is sold → DEDUCTIBLE under §280E. (2) RETAIL/OFFICE/ADMINISTRATIVE SPACE: this portion is SG&A → NON-DEDUCTIBLE under §280E. The allocation method: SQUARE FOOTAGE is the most defensible methodology (also used for utility, insurance, and security cost allocation). For a 10,000 SF facility: 4,000 SF cultivation + 2,000 SF processing + 2,000 SF retail + 2,000 SF office. Cultivation/processing = 6,000/10,000 = 60% → capitalized into COGS. Retail/office = 4,000/10,000 = 40% → non-deductible SG&A. The cannabis operator's incentive: maximize the cultivation/processing square footage designation. The IRS scrutinizes square footage allocations for reasonableness — 'paper allocations' not reflecting actual space use are rejected.
Practitioner & Systems Framework
💻 ERP Architecture
Square footage documentation is critical for §280E defense: (1) Floor plans showing allocation of each room/area to cultivation, processing, retail, or office use, (2) Square footage calculations verified by measurement, (3) Consistent application across all facility costs (rent, utilities, insurance, security), (4) Documentation of any space use changes during the year. For multi-location operators: each location requires its own square footage analysis. Under ASC 842: the ROU asset and lease liability for the entire lease are recognized; the allocation of the LEASE EXPENSE between COGS and SG&A is separate from the lease accounting.
⚠️ Audit Flags
Space allocation for §280E is among the most-audited items in IRS cannabis examinations: (1) Is the square footage documentation contemporaneous (made at the time of allocation, not reconstructed for audit purposes)? (2) Is the retail/office space classification consistent with actual use? (3) Does the allocation make operational sense (a 3,000 SF cultivation operation and a 500 SF retail counter in a 3,500 SF total facility should allocate approximately 85% to cultivation). (4) Changes during the year — if the company expanded its retail space or reduced cultivation space, is the allocation updated?
📄 Required Documentation
Facility floor plan with space allocation labels, square footage calculation worksheet (by use category), consistent allocation table applied to all facility costs, ASC 842 ROU asset and lease liability (total facility), §280E allocation between COGS and SG&A (square footage basis), landlord certificate confirming total square footage, and any space use changes documentation.
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Expert Analysis by Qusai Ahmad
General Accountant Supervisor & IFRS Specialist
Specialized in SAP GUI automation and Middle Eastern tax compliance. Building digital tools for the next generation of finance leaders.
Related Journal Entries
Cannabis & Regulated Substances
IRC §280E — Complete Disallowance of Ordinary Business Expenses (Cannabis-Specific Tax Law)
Cannabis & Regulated Substances
§471 Inventory Cost Capitalization — Maximizing COGS for Cultivators Under §280E
Cannabis & Regulated Substances