Should Landlords Establish Home Offices?

Every once in a while we get a question about whether or not landlords qualify for the home office deduction? Also, can landlords actually benefit from establishing one?

In today’s Tax Smart Newsletter we’ll address both of these concerns because as you’ll see, home offices can open the door to some lucrative tax deductions if you frequently travel locally for business purposes.

Do Landlords Qualify for the Home Office Deduction?

The answer to this question is the proverbial, it depends. 

The first question is, is your rental activity considered a trade or business or simply an investment?

The answer is important because business owners can typically claim the home office deduction, while investors cannot.

Unfortunately, there is no bright-line test that can answer this question for you, however, there are some general guidelines that can help make that determination. 

Investors typically buy a property, hire a property manager, and collect checks. They play a relatively passive role. Whereas business owners play a more active role, often handling the activities that a property manager would handle. These include, but are not limited to:

• Performing repairs and maintenance
• Completing improvements or arranging for others to do them
• Finding and screening tenants 
• Preparing and negotiating leases and other rental agreements
• Responding to tenant complaints and inquiries
• Collecting and depositing rents

Again, while there is no bulletproof answer, the more of these activities you perform, the greater the chance your rentals will be considered a business in the eyes of the IRS. 

And if you’re wondering what the tax courts have to say, a tax court case, Curphey v Commr., 73 TC 766, ruled that it is indeed possible for rental activities to rise to the level of a trade or business and allow the owner to claim a home office. 

Home Office Requirements 

Assuming your rental activity is a business, per IRC § 280A, a home office must be used: (1) regularly and exclusively as the principal place of business; and (2) regularly and exclusively as a place to meet or deal with patients, clients, or customers in the normal course or trade of business.

Now if you work offsite, which is often the case for many landlords, you can still deduct the home office if it is the location where you handle your administrative work such as paying bills, handling paperwork, filing taxes, and related activities.

Can Landlords Actually Take The Home Office Deduction?

Drum roll, please…It depends.

The home office deduction is limited to the income generated from the associated business. 

If you’re like most Tax Smart Investors, chances are your properties are generating a loss because you’re sheltering your rental income with depreciation and other expenses. This means you won’t have income from your rental business and thus can’t deduct the home office.

The good news is home office deductions not taken in the current year may be carried forward indefinitely. This means you can take these deductions in future years if your rental business generates taxable income. 

Why Establish a Home Office?

So you may be wondering if I can’t take the home office deduction today, is it even worth the hassle of claiming one?

Again, the answer is…it depends

If you do a lot of local travel for your rental business, it might be worth claiming. 

This is because when you commute from your home to the first business location of the day, let’s say your rental property, it is generally considered a personal commute and the mileage does not count as business mileage. 

However, establishing a home office makes your home a place of business which means your commute from your home office to a business location, such as your rental property, becomes a business commute. 

With the standard mileage rate being 58.5 cents per mile in 2022, this can add up quickly if you do a lot of local traveling for your rental business. 

It can be even more impactful if you use a business vehicle more than 50% for business and use the actual expense method for your vehicle-related expenses. This is because if your vehicle meets certain requirements (we’ll discuss this in next week’s newsletter), it’s possible to depreciate a portion, or even the entire vehicle’s cost, in the year you place it into service. 

Example

For example, let’s say you acquire a Ford F150 for $50,000 and use it 75% for business. You can deduct $37,500 of its cost in the first year you place it into service. 

If you’re in the 24% tax bracket that can potentially save you $9,000 in federal taxes. If you’re in the 37% tax bracket that can save you up to $13,875 in federal taxes. 

Having said that, rental losses are generally considered passive unless you qualify for the special loss allowance or qualify a real estate professional, which means the loss might end up being suspended and carried forward to future years.

However, this can be a lucrative strategy for real estate professionals, or if you expect to have rental income or gains from the sale of real estate in any given year. 

The Bottom Line

As a landlord, you may qualify for a home office if you play an active role in your rental activities and the activities rise to the level of a trade or business. 

Although you might not be able to claim the home office deduction immediately because you have a loss from your rental business, these deductions can be carried forward into future years. 

Lastly, and probably most importantly, the home office also makes your home a place of business causing travel to and from local business locations to be considered business mileage and which can significantly increase your vehicle-related deductions.