It’s a new year, which means a new opportunity to save on taxes.
One way to create valuable tax deductions is to establish a home office for your Schedule C or corporate business.
And just in case you didn’t know, doing so isn’t only limited to sole proprietorships, partnerships, or corporate businesses. If you rent properties, you can also establish a home office to manage those rental properties and deduct the cost on your Schedule E.
However, there are a few hurdles that you must overcome to successfully do so:
Rental activities must qualify as a “trade or business.”
Under the tax law, your rental activities must qualify as a “trade or business”.
This is relatively simple and means that you will need regular and continuous involvement with your rental activities to meet the requirement.
The facts and circumstances of your rental activities will determine whether or not your rental activities qualify as a trade or business, and court cases will provide guidance on that.
Qualified space must be set aside for a home office.
To qualify for the home-office deduction, there must be space set aside in your home that is used regularly and exclusively as the principal place of business for your rental activities.
This has become easier than it has in previous years before lawmakers changed the rules of your principal place of business to include the space you use for administrative or management activities.
The above is provided that there is no other fixed location where you conduct those activities.
Changes to Household Expenses.
By establishing a rental property home office, two things happen with your household expenses:
- Non-deductible household expenses are turned into tax deductions.
- Household expenses normally deductible on Schedule A are moved to your rental properties on Schedule E.
After the passage of the Tax Cuts and Jobs Act, it is important to note the following changes:
- A $10,000 limit on Schedule A state and local tax deductions, and
- The lowered amount of the mortgage on which you deduct mortgage interest from $1 million to $750,000.
Elimination of Commuting Expenses.
When you don’t have a qualifying home office, your commuting mileage from home to your first business stop and from your last business stop back home is non-deductible.
If the rental property’s principal office is in your home:
- You have no commuting mileage from your home to/from your rentals if the rentals are within 50 miles of your tax home.
- If your rentals are outside of the area of your established rental property’s tax home, then the mileage from your home to/from the rentals is deductible business mileage
Classification as a Real Estate Professional.
Assuming you qualify as a real estate professional under the tax law, then 100% of your rental losses can be deducted in the year in which they occurred.
However, the biggest hurdle in the classification as a real estate professional is that you must show the following:
- That you spend more than 50% of your personal service work time in real property trades or businesses in which you materially participate, and
- That you also spend more than 750 hours of service during the tax year in real property trades or business in which you materially participate.
When you have a rental property home office that qualifies as a principal place of business per the tax code, it makes it easier to qualify as a real estate professional since your time spent on deductible travel to/from rental properties counts toward the time requirements.
Claiming Your Deduction.
Not only do the Schedule E instructions make it difficult to claim your deduction by failing to provide any explanation about where to put the home-office deduction, but they don’t even mention a home office at all!
However, the instructions do state that you can deduct ordinary and necessary business expenses, and that is where the home office falls in. Additionally, as established in the precedent-setting case Curphey, the home office is allowable as an expense against rental business income.
For more information about how your rental properties can be structured to provide you with the best tax benefits, call our office at (732) 566-3660.