Tackle the Gray Area and Claim a Home Office Deduction on Your Rental Property Business

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For those of you who run a real estate rental business, you may find that the IRS is a little tougher on you about claiming a home office deduction. The sticking point is that, depending on your circumstances, the IRS may consider your real estate business an investment rather than a business. In order to claim this deduction, your home office must be connected to a “trade or business”. So, the trick is to provide documented evidence that your rental endeavors are a business you run.

The Gray Area

A home office can save you thousands on taxes because you are able to deduct a percentage of your mortgage interest, property taxes, and even utilities as business expenses. However, when you’re lurking in the shadows of this gray area in tax law, you can find yourself arguing with an auditor who simply does not believe that your deduction is legitimate.

That is exactly what happened to Dr. Edwin Curphey, who owned a rental property business and had his home office deduction rejected. He ended up taking his case to court and winning his deduction.

It usually seems like the IRS has no end to specifications and rules to follow. However, in the case of deducting a home office for your rental property business, the law is fairly vague. This gray area leads some auditors to interpret such situations in different ways, so you have to be prepared with the right knowledge when tackling this deduction.

Unfortunately, no set method exists for proving your claim. You can, however, piece together information that will help in making your case. In order to determine whether you qualify for the deduction, your best bet is checking out precedent cases to see who has previously won the deduction and who has not.

Gray Area Guidelines

What’s the main difference between an investor and a business owner? It’s pretty simple. An investor collects money without having to perform any work, but a business owner actively works with a property. That means to be considered a business, you need to show the IRS that you do more than simply handle money[1].

Here’s where the fuzzy requirements come in. In order to qualify, you have to present evidence of activities that indicate you are doing work with your rental properties, but there is no definite set of activities that are required by the IRS. Some actions that indicate actual business activity may include[2]:

  • Management
  • Making repairs
  • Performing cleaning tasks
  • Advertising
  • Resolving tenants’ problems

You may not do all of these in association with your real estate rental business, but your chance of making a successful deduction increases with the more you do. The good news is you can still claim your rental property income on the Schedule E (just like investment property) while making the case that it’s a business. This means you’ll be able to avoid the self-employment tax, unless you offer your tenants significant services, such as a housekeeper[3]. In that case, you’ll need to use the Schedule C[4].

What If You Run Multiple Businesses?

If you run multiple businesses, you may be using the same home office space for all of them. In that situation, you’ll have to be extra careful because each business has to meet the home office requirements in order to qualify your office space for a deduction[5]. When one of the businesses does not qualify, you should find a separate office space for it, if possible. Otherwise, you’ll lose your legitimate deduction for the business or businesses that do qualify!

Three simple requirements must be met for the home office deduction:

  1. The home office must be your principal place of business;
  2. You must use it regularly; and
  3. The space must be used exclusively for business purposes.

In general, the requirements for deducting a home office are not hard to meet. Owning rental property, however, is a little different from other businesses. Don’t let a misunderstanding of the rules keep you from claiming your legal deductions. If you’re operating your real estate rental business and performing regular business activities for it, then it qualifies, regardless of whether you have another full-time job.

  1. Neill v Commr., 46 BTA 197.
  2. Curphey v Commr., 73 TC 766.
  3. Reg. Section 1.1402(a)-4(c)(2).
  4. Schedule E Instructions (2013), dated Dec. 4, 2013, at p. E-5 (under “Line 3”).
  5. Hamacher v Commr., 94 TC 348.