Cannabis Real Estate and Leasing: Tax Treatment Under IRC 280E

Real estate is usually the largest fixed cost in a cannabis operation, whether you are growing flower in a 20,000-square-foot warehouse or selling it from a street-level dispensary. The federal tax treatment of that cost depends on two things: whether you own or lease the property, and whether the expense can be classified as part of cost of goods sold. Because marijuana remains a Schedule I controlled substance under federal law, IRC 280E denies every deduction and credit except cost of goods sold (COGS) to any business that “consists of trafficking in controlled substances.” That single rule reshapes every real estate decision a cannabis operator makes.

What does IRC 280E actually block?

IRC 280E is one sentence long, and it is absolute. No deduction or credit is allowed for any amount paid or incurred during the taxable year in carrying on a trade or business if that trade or business consists of trafficking in controlled substances prohibited by federal law or the law of any state in which the trade or business is conducted. The only carve-out is for cost of goods sold, which is not technically a “deduction” but a reduction to gross receipts under IRC 471.

For a cannabis operator, this means expenses that would be fully deductible for any other business (rent, utilities, insurance, depreciation, property taxes, repairs) are nondeductible unless they qualify as part of COGS. The distinction between a deductible COGS component and a disallowed operating expense is the central tension in cannabis tax planning, and nowhere is it more consequential than in real estate.

For additional context on how 280E interacts with employee costs, see our guide on cannabis payroll and employment tax.

Can a cannabis operator deduct rent on a leased facility?

Only partially, and only if the rent is allocable to production. Under the COGS framework, costs that are direct or indirect production costs can be included in inventory. Rent on a cultivation or manufacturing facility qualifies as an indirect production cost under Treas. Reg. 1.471-11(b)(3), because it is part of the overhead of producing the product. That rent gets capitalized into inventory and recovered when the inventory is sold.

Rent on a retail dispensary is a different story. Selling costs are not production costs, and they do not flow into COGS. Dispensary rent is a below-the-line operating expense, and IRC 280E disallows it entirely. The operator pays the rent, gets no tax benefit from it, and the economics of the retail location have to justify the full pre-tax cost.

If a single facility serves both production and retail functions (a vertically integrated operation with a grow room and a storefront under one roof), the rent must be allocated between the two activities. The allocation method has to be reasonable and defensible. Square footage is common. If 70% of the building is devoted to cultivation and processing and 30% is the retail floor, 70% of the rent is allocable to COGS and 30% is disallowed. The IRS will scrutinize that allocation, so the methodology needs to be documented and consistent.

What happens if the cannabis operator owns the property?

Owning the property introduces depreciation, mortgage interest, and property taxes into the equation. All three are subject to the same 280E filter: deductible only to the extent allocable to COGS.

Depreciation on a production facility is an indirect production cost that flows into inventory under Treas. Reg. 1.471-11. The building itself is depreciated over 39 years (nonresidential real property under IRC 168(c)). Cost segregation studies can reclassify certain building components (electrical systems, plumbing specific to grow operations, HVAC) as personal property with shorter recovery periods (5, 7, or 15 years), accelerating the depreciation that flows into COGS.

The problem is that accelerated depreciation only helps to the extent the depreciation is allocable to production. The portion allocable to retail or general administration is disallowed under 280E. A cost segregation study on a dispensary building produces faster depreciation that the operator cannot use.

Mortgage interest on the property follows the same rule. Interest allocable to the production portion of the facility can be included in COGS as a cost of carrying the production asset. Interest allocable to retail space is disallowed. Property taxes split the same way.

The net effect is that owning the property as a cannabis operator means carrying the full economic burden of ownership (mortgage payments, property taxes, maintenance, insurance) while recovering only the production-allocable share through COGS. The retail-allocable share is a permanent tax cost with no offset.

How does the real estate holding company strategy work?

This is the structural answer to the 280E problem on real estate. Instead of the cannabis operator owning the property directly, a separate entity (an LLC or corporation) owns the real estate and leases it to the cannabis operator at fair market value. The holding company is not trafficking in a controlled substance. It is a real estate rental business. IRC 280E does not apply to it.

The holding company can deduct, as ordinary business expenses, everything the cannabis operator cannot: depreciation (including accelerated depreciation from a cost segregation study), mortgage interest, property taxes, insurance, repairs, and maintenance. Those deductions offset the rental income the holding company receives from the cannabis operator.

The cannabis operator, meanwhile, pays rent. That rent is an expense of the cannabis business, subject to the same COGS allocation rules described above. Production-facility rent flows into COGS. Dispensary rent is disallowed. But the total tax cost across the two entities is lower, because the holding company is deducting the property expenses at 100% rather than having them partially disallowed under 280E.

What are the requirements for the related-party lease?

The IRS looks closely at related-party transactions in the cannabis space, and the lease between the holding company and the cannabis operator has to survive scrutiny. The core requirement is that the lease must be at arm’s length, meaning the rent must reflect what an unrelated third party would pay for the same property in the same market.

If the rent is above fair market value, the IRS can recharacterize the excess as a distribution, a contribution, or a disguised payment that does not qualify as rent. If the rent is below fair market value, the IRS may argue the arrangement lacks economic substance and collapse the two entities.

To support the arm’s-length standard, the holding company should obtain a commercial appraisal or broker opinion of value for the lease rate. The lease agreement itself should be a written, arms-length commercial lease with standard terms (duration, renewal options, responsibility for maintenance, insurance requirements, default provisions). The holding company should operate as a genuine business: maintain a separate bank account, file its own tax returns, and hold its own insurance policies.

The holding company also needs genuine economic substance beyond just holding the cannabis operator’s property. Having multiple tenants, owning other properties, or at minimum maintaining independent management and governance all strengthen the position. A single-asset entity with a single related-party tenant is not automatically invalid, but it sits at the thin end of the substance spectrum.

Does cost segregation work for cannabis property?

Yes, but only when the depreciation is actually recoverable. For the real estate holding company, cost segregation is fully effective. The holding company is not subject to 280E, so accelerated depreciation on reclassified components (5-year personal property, 15-year land improvements) reduces taxable rental income dollar for dollar.

For a cannabis operator that owns its own property, cost segregation accelerates depreciation that is only partially useful. The production-allocable share flows into COGS faster, which helps. The retail-allocable share is still disallowed. Running a cost segregation study on a dispensary-only building that the cannabis operator owns directly produces depreciation the operator cannot use, making the study fee a waste.

The practical rule: cost segregation belongs on the holding company’s books, not the cannabis operator’s. If the operator owns the property directly and there is no plan to restructure into a holding company arrangement, a cost segregation study is only worth the fee if the production allocation is high enough (typically above 50%) to justify the cost of the study.

For a broader look at structuring ancillary businesses to operate outside the 280E perimeter, see our guide on ancillary cannabis business tax planning.

What about state tax implications?

State treatment varies. Most states that have legalized cannabis conform to IRC 280E in some form, though a growing number have decoupled. California, for example, does not apply 280E for state income tax purposes, allowing cannabis businesses to deduct ordinary business expenses on their state returns even though those same expenses are disallowed federally. Colorado and Oregon take similar positions.

In states that decouple from 280E, the holding company strategy still provides federal tax benefits, but the state-level urgency is reduced because the cannabis operator can deduct its property costs on the state return regardless of structure.

In states that conform to 280E, the holding company provides both federal and state tax savings, making the case for restructuring even stronger.

The state analysis has to be done jurisdiction by jurisdiction. This is one area where the difference between states is large enough to change the structuring recommendation entirely.

How should existing operators restructure?

Operators who currently own their facility directly and want to move to a holding company structure need to plan the transfer carefully. Transferring appreciated real estate from the cannabis entity to a new holding company can trigger gain recognition if not structured properly. A contribution to a partnership under IRC 721, a transfer to a controlled corporation under IRC 351, or a like-kind exchange under IRC 1031 may provide nonrecognition treatment, but each has its own requirements and limitations.

The transfer may also trigger transfer taxes, reassessment of property taxes (depending on the state), and mortgage due-on-sale clauses if the property is financed. The lender has to be consulted before any transfer, and the title and insurance need to be updated.

The restructuring should be treated as a real transaction, not a paper exercise. The holding company needs its own EIN, its own bank accounts, its own operating agreement, and its own books. The lease needs to be executed before the first rent payment, and the rent needs to be supported by a market analysis.

What records should the holding company maintain?

The holding company should keep the same records any commercial landlord would: the lease agreement, rent payment records, property tax bills and payments, insurance policies, maintenance invoices, depreciation schedules, and (if a cost segregation study was performed) the full study report. The company’s tax returns should be prepared separately, and the rental income and expenses should be reported on the appropriate form (Schedule E for a passthrough entity, or the corporate return if a C corporation).

If the IRS examines the cannabis operator and questions the rent deduction, the holding company’s records are the first line of defense. Clean, complete, contemporaneous records demonstrate that the holding company is a real business with a real economic purpose, not a shell created solely to circumvent 280E.

Related guides:

• Cannabis Ancillary Business Tax Planning
• Cannabis Cost Of Goods Sold Cogs Calculation
• Cannabis Entity Structure Llc Scorp C Corp
• Cannabis Irs Audit Risk Compliance
• Cannabis Payroll Employment Tax 280E

This guide is general information, not tax advice for your specific situation. Which points apply, and how, depends on your facts.