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May 23, 2024 | read

163. Do Landlords Qualify For The Home Office Deduction? & Why You’d Want To Take It W. Justin Shore

Thomas Castelli

In this episode, we discuss the controversial topic of whether or not landlords qualify for the home office deduction and the not so obvious, but potentially big, benefits of claiming one.

This episode is sponsored by Landlord Studio and Tax Smart Investors.

Full Transcript:
This podcast has been transcribed using AI, please excuse spelling, grammatical, and other errors.

Alright, so diving right in here, we’re going to talk about do landlords actually qualify for the home office deduction? I think the answer of course is it depends. 

Justin Shore 2:27
It depends on whether or not your rental activity is rising to the level of a trader business.

Thomas Castelli 2:33
Right? Right, right. So not all activities Rise Rise to what’s known as a section 162 trade or business which for our purposes here, we can just consider that your normal, just a normal trade or business or a section 212 activity or 212 activity, which is basically an activity that generates income but is not a trader business. And to make a long story short trades or businesses can claim a home office, if you don’t have a business, then you can’t take the home office deduction for the most part. And I think what it comes down to is whether or not your rental activity rises to that level or trade or business. Or if it’s more or less an investment that you don’t really played much of a role in then in those cases, for the most part, you’re not going to be able to take the home office deduction. And the good news is here is we have is all backed up by a case. So the case was curfew verse conditioner and make a long story short, he was a doctor and what he did he own six rental properties. And he self managed these properties. So that means that he was responsible for furnishing some of these properties, as well as finding tenants coordinating repairs, and maintenance, a typical type of things that you would see a property manager do. And because he was able to self manage these properties, the cat court ultimately found that it rose to the level of a trade or business and therefore he was granted a home office deduction. So that’s good news for landlords. If you are basically managing your property and you’re taking a basically playing an active role, there’s a good chance it’s going to rise to the level of a trade or business. But of course, you’re gonna want to discuss that with your own tax advisers just to make sure because there really is no bright line test, assuming your rental activity rises to a level level of a trade or business. The next question is whether or not you should actually take a home office deduction, or do you actually get the deduction itself?

Justin Shore 4:29
Yeah. And, you know, one of the issues that commonly comes up and I’ve heard, like a lot of our clients will leave to kind of bring up is, oh, I don’t take that deduction, or B because, you know, I’ve been told that I’m not going to be able to anyways, because thanks to depreciation, my properties are producing a tax loss. So I’m not going to be able to take the deduction anyways. So, you know, they kind of have this, then what’s the point? You know, like, if I can’t take it anyways, and so kind of, you know, first fallacy there yet, yeah, you may not be able to take that deduction in the current year, it’s going to get carried forward into the future years as well. But the other thing, the other kind of component of the detail with this is that even if you’re not able to take that deduction, the fact that it is being paired so closely with enabling you to take more of your travel deductions that are related to your local area, it can still be very significant. So it could still be basically opening the door or opening the window for additional deductions. So you don’t want to be closing yourself off from that potentially.

Thomas Castelli 5:37
Right. Right, right. 100%. So basically, you know, the home office deduction is going to be limited to the income that’s generated from the activity. And as most landlords are out there, you probably have between your depreciation, like Justin said your other expenses, you’re probably generating a loss for tax purposes, which means, unfortunately, you’re not going to be able to take the home office deduction, at least today. And it’s going to get carried forward to future years when at some point, you might be able to use it. But the big takeaway is that you make your you’re making your home a place of business. And that’s a key fact, that’s a key, that’s something very key because what happens is, if you were to drive from your home, to your rental property, which your rental property is a business location, or to the bank, for business or Home Depot, it’s going to be considered a personal commute, because you’re driving from your personal residence to a business location. So that first communion of the day is going to be a personal commute. And those miles if you drive a car or vehicle, are not going to be considered business miles. However, when you establish the home office, you’re making your home a place of business, and now the travel from from your home office, a place of business to that rental property, to Home Depot to the bank, to the lawyer’s office, wherever is going to be come a business mile is now going to be tax deductible. And that’s going to be key to maximizing your vehicle related deductions as we’re about to get into right now.

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Justin Shore 7:00

And those details are also solidified and backed up in the curfew case, because they, the IRS was taking the stance that his place of business was where his full time job was as as a dermatologist. But the tax court actually ruled in his favor on this particular detail as well, I say that you can have more than one place of business, if you especially if you have more than one business, he was a dermatologist, you know, it was in that line of work or that trader business, but he also had rental properties and was managing those rental properties from his home office. So it was it was solidified there as well as they pointed out the fact that just because he went to work, you know, whatever, if it was 40 hours a week at the hospital, he still had his place of business for his rental operations in his home office.

Thomas Castelli 8:00
Right right. So so that that was solidified in this case also solidified in the case is that the home was made a place of business and allowed him to deduct the travel. So this is a very key case, not only for landlords, but for other businesses as well who are wondering whether or not they can deduct the business miles to and from different business locations. So I just want to give an illustration to show just how impactful this can be. Let’s say that you go and you buy a brand new vehicle for your business, let’s call it a Ford F 150 Ford F 150s Just happened to qualify as a vehicle that could be potentially deducted 100% in the year that you acquire the vehicle. So let’s say you buy that Ford F 150. And you drive it exclusively for business purposes, from your home office, to your rental properties, and the related business locations that you have for when you run your rental business. So you’re going to have 100% business usage in this case. And if you get 100% business usage, thanks to your home office, you can deduct the entire cost of the vehicle in the year you acquire and place that vehicle in the service. So let’s say the Ford F 150, you get a model that costs $50,000. Now guess what you’re gonna get a $50,000 deduction, thanks to your ability to use the vehicle for business purposes and a $50,000 deduction. Let’s just say you’re at the 24% tax bracket, that’s going to be worth $12,000 in tax savings to you. Now if you’re at the 37% tax bracket, that’s going to be about $18,500 in tax savings. So it’s not something to laugh at. Now the issue is going to become is going to be whether or not you can actually make this loss that you get or this loss from the vehicle essentially active and be able to duck that against your W two or other business income. And that’s going to come down to whether or not your real estate professional because if you’ve been following along so far, you’ll probably see that this is all tied to your rental activity. All rental activities are passive by default for the purposes of whether or not you can deduct them against your other income. So any last From your rental activity, unless your real estate professional are going to be passive, including the loss that you’d get from a vehicle. So if you’re not a real estate professional, you purchase the vehicle, and you get a $50,000 deduction, it’s going to be considered a passive loss. And it’s going to be suspended and carried forward into future years, when you either have passive income, perhaps from your rental properties, or you sell one of your rental properties for a gain, the losses can be unlocked. So it’s still very beneficial to do this, even if you are a passive investor. And it’s even more beneficial to do it. Of course, if you’re a real estate professional, and you could turn that loss non passive and use it to offset your income from other sources.

Justin Shore 10:37
Yeah, absolutely. One of the other one of the other questions I get asked pretty regularly on this, too, is, you know, do I have to have a, like four walls, you know, closed off space that that is an office? And you know, the essay, the answer is no, you this space just has to be a dedicated space use for your business. So you don’t have to have an entire spare bedroom. Yes, it is going to be easier to illustrate and document of course, but the if you if you pull up publication 587, which is, you know, the IRS publication that governs everything, all the ins and outs of the business use of a personal residence. It’s not even very far. And it’s on page three, where it’s addressing the exclusive use test, and it’s addressing the fact that this space has to be exclusively used for business. The the wording that they finish, the first paragraph with says states, the space does not need to be marked off by a permanent partition. It says the area used for the business can be a room or other separately identifiable space. So you know, it’s you don’t necessarily have to have a red line in the middle of you know, of the carpet or whatnot. But I think that’s important because, you know, as long as you can have that, justifiably separate space where it’s okay, this is where my desk, my computer, my filing cabinet, is even supported a little bit again, in this in the curvy text, where they are basically laying out exactly what he had in the room, equipment wise, like including a desk, including a telephone, they even went so far as to dress like the closet space that he used system where all of like his you know, maintenance materials, paint and stuff like that. But the main main point being is Yeah, you don’t have to have a spare bedroom to turn into an office necessarily to take this deduction, you just have to make sure that it is dedicated for that purpose. You know, and one of the best ways that you could probably document that it especially is just take a picture of the room, you know of the space, maybe even a couple of pictures to kind of really outline okay, like this, you can see that this is definitely my my workspace, it’s not office, but it’s definitely a dedicated workspace that way, especially if it’s in a case where after you have moved, you may not even have access to the space anymore. If you were in an audit situation, you have excellent documentation right there to be able to say, yeah, it was, you know, it was off this the side of the living room around the corner, but here it is, it was dedicated for my home office space.

Thomas Castelli 13:28
The bottom line here is the home office for landlords, the home office deduction is not really for the home office deduction in and of itself, it’s really to establish your home as a place of business. So you can maximize your vehicle and local travel related expenses by making your home a place of business. That’s the bottom line.

Justin Shore 13:46
So the other question, another question that we get pretty regularly too, is, you know, how, like, what can I deduct for my home office space and it kind of boils down to the fact that there’s there’s actually two different methods. There’s the actual expense method and the simplified method, the actual expense method is going to incorporate basically all the bills and expenses that go into maintaining a home. So those are going to be things like your property taxes, mortgage interest, your property insurance, utilities, internet, if you’ve got internet that’s able to be you know, separated out from cable, I don’t think you could really justify cable as as an expense of the home office per se. But when when you compile all those expenses for the entire year, then and that would even include like roof, repairs and maintenance as well on you know, items like that are going to factor into the maintenance of the entire home like roof repairs. Once you factor in all those expenditures, then you would be then you’d have to allocate your square footage of your home office based off of what the percentage of the home office is out of the entire square footage of the house. So you know if your home office takes up 15% of the space in your home Home, then you’d be allocating 15% of all of those expenses to your home office, they can be fairly cumbersome. Of course, I mean, that’s a lot of receipts bills and things that you’ve got to keep track of. So a lot of our clients are a little bit more geared towards the, the simplified method, which is very aptly named, it’s much, much simpler. And what you do is you just measure the square footage of your home office and multiply that by $5. With a maximum of 300 square feet, you don’t have to keep all the receipts from all those expenses, like insurance and taxes and things like that, but makes it a lot lot simpler, a lot easier to as far as reporting that onto your tax return. And the other item that this kind of plays into a little bit more often, too, that we get a lot of questions on is this this rumor, this idea that claiming a home office deduction is actually going to increase your your audit risk or somehow expose you to an audit if you find the home office deduction?

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Thomas Castelli 15:57
Right. And there’s no, there’s no real evidence to really conclude that what ends up happening at least from from my understanding, and my experience is people end up getting audited for Schedule C. And in connection with that, they end up getting audited with further home office as well. Along with that, sometimes it’s just what the IRS does, they ordered they find one thing and then they decide to kind of see what else they could poke and prod around. While they’re there, there really is no hard evidence to conclude that because you claim the home office deduction, that that in and of itself is going to create an audit scenario. Secondly, when you take the simplified method, it’s usually going to result in a lower audit rate. Because the simplified method is really simple, you get, you’re taking $5 per square foot up to 300 square feet. And that’s a $1,500 deduction, there’s not that much room there for you to take advantage. Whereas if you use the actual method, you start taking a portion of your actual expenses. Well, now there’s a lot of room for you to kind of take advantage, maybe you’re buying things excessively for the home office and claiming really large deductions. And that’s something the IRS is going to take a look into. And if you look back at what Justin said before, you also need to have a lot more substantiation when you do take those expenses, and just put yourself at a risk for if and when you are ever audited, God forbid, for a home office deduction, and you are using the actual method. If you can’t generate all that substantiation for that, that’s an opportunity for the IRS to go ahead and disallow it. So kind of the bottom line here is, there’s no conclusive evidence that shows that home offices actually do increase your audit risk. And when you are audited, there’s usually a lot more for the IRS to go on when you have when you use the actual expense method versus the simplified method. And if we’re tying this all in here, for landlords specifically, if you’re running a different business, and you’re not running a rental business, the conversation is a little bit different. I’m zoning in right here for the landlord specifically. And again, because you’re going to have a rental loss for the most part or most landlords are or you should have a rental loss, the simplified methods probably going to be the route to go. Just because you’re not going to be getting, you’re not going to be getting a tremendous benefit from the home office deduction in and of itself, better fly under the radar, take the simplified method. And then just really again, where the real perks of taking a home office deduction are for landlords or establishing home office rather, is the ability to turn your home into a place of business to increase your business miles. That’s really the key. And that’s why you should take one if you’re eligible to take one couldn’t agree more. So I think that’s about all for today. Thanks for tuning into this episode. Before we leave, I did want to let everybody know about our tax smart bootcamp that’s launching this upcoming Monday on January 10. It’s a four week course or Brandon goes in depth on the real estate professional status, short term rentals as well as repairs and improvement deductions. We’re going to have a weekly live q&a On Thursdays, the price of the course is traditionally $397. But if you’re listening to this podcast right now, I’m not going to post this in the show notes. This is just if you’re listening and you made it to the end of this podcast, you can get the course for 50% off by using the code capital J n. So that’s Jan 22. Exclamation mark ready. So you have to do go to WWE dot tech smart investors, click on courses, go to tech smart boot camp and use promo code capital J A N 22 explanation Mark such shift one, right and you’re going to be able to get the course 50% off and that’s only if you listen to this podcast and stay this long because that promotion is no longer in play. So we look forward to seeing some of you in that boot camp. If not, we’ll see you next week on the next episode of The Real Estate CPA podcast.

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