Home office tax cuts are encouraging more people to switch their workplaces. But sadly, most people assume they are not eligible for a tax cut just because the house or property is a rental. That’s an irony. You have no idea how much money you have been letting go all this year. Without more suspense, let’s get it straight: can you have a home office for a rental property?
You are eligible for a tax cut even though you are not the homeowner. The methods still apply the same for you. The only discrimination is that you don’t get a return on depreciation or home improvement costs.
You have to dive deeper to fully understand whether your situation allows for a tax cut or not. so, without further ado, let’s start the quest.
Can You Have A Home Office For Rental Property?
As you know, the Tax Cuts & Jobs Act introduced significant tax reform in 2017. That’s why there are a lot of confusion regarding home office tax deductions since 2018. The reform clearly states that you are only acceptable for a tax write-off if you are self-employed. Previously, employees who prefer remote working seemed suitable to ask for such a write-off as well.
But that’s about it. There was no specific restriction for renters. That means you are still eligible even after the reform act is published.
Criteria For Getting Tax Deduction On Home Offices Within A Rented Property
It doesn’t matter whether your home office is a personal or rental property, you are accepted for a tax cut as long as you meet the criteria. The most crucial criterion you have to face is employment status. You have to be a self-employed person working remotely to be considered the tax concession. But what does “self-employment” even mean? Check it out.
1. Do You Work For An Employer?
The first question the authorities are going to ask is whether you have an employer or not. It’s simple, if you have an employer paying you at the end of each month, you are not self-employed. But previously (before 2018), even employees were allowed tax breaks if they did their work remotely. But the condition was that it has to be the only option available.
For example, if your employer gives you the flexibility to work either from the office or home and you go with the second one, it won’t be accepted. The employer isn’t gaining anything from your decision to work remotely.
However, if the employer couldn’t afford office facilities for you and hence you were forced to work from home, you could ask for a tax cut. But not anymore. The Tax Cuts & Jobs Act clearly restrains all remote employees whether working willingly or unwillingly from getting any tax benefit out of it. Sad, but we have to accept it.
2. Do You Receive a Monthly Paycheck?
Anyone who works from home and doesn’t have an employer is eligible for the benefits. But there’s a catch. The term self-employed covers anyone who doesn’t receive a monthly paycheck with half-paid Medicare and social security taxes. It’s more specific and tends to end any confusion you might have.
Freelance workers would be a good example here. They are individual contractors and don’t work for any specific boss. And more importantly, they only receive a fee for their job and not a paycheck. They are entitled to pay the full Medicare and Social Security taxes out of their income.
That’s the same for someone running a small or medium size business from his/her house. Such job types make you a self-employed person according to the definitions of the IRS.
3. Is Your Home Business Registered As A Corporation?
Businesses registered as a corporation (LLCs) won’t be suitable for a tax break under this act. Even if you are currently running or operating everything from the house, your business type disqualifies you from the deduction.
However, suppose you run a solo business and is fully liable for its loss or profit. In that case, the home office you are using will be eligible for the return. The same goes for a partnership business. But the condition is that it can’t be registered as a corporation.
Both partners need to take liability for the business they are running. In that case, you only have to satisfy the “three basic home office requirements” like any other remote worker. We will explain them below.
Which Home Offices On Rented property Will Disqualify?
Knowing what disqualifies you is equally important. Luckily, it’s the same as owning the property and building a home office there. Check out the three requirements your home office must fulfill after your job type has been approved by the authority.
1. Is It Distinguishable?
First of all, the office must have a boundary. We don’t necessarily mean four walls by that. But you must be able to show a separate corner or area that’s measurable when the auditors visit. It’s absolutely okay to use another room’s space like the living or couch area. But it has to be distinguishable.
For example, the office needs a desk at least. So, you can point out the desk area as your office. If you use your bed, sofa, or dining table to complete office tasks, that’s won’t count. You are using those areas for purposes other than work (sleeping, sitting idly, or eating). That ruins the “exclusivity” required for a home office.
2. Is The Office Really Necessary?
After passing the first stage, you have established an exclusive office area. But can you show the “need” for this office to the auditors? Does your job really require you to have an office?
If you are a blogger, who can easily get the job done with one laptop, might have complications convincing the authority.
However, if you are a freelancer who needs access to multiple electronic devices to complete tasks for his clients, you have a visible need for an office. It’s the same for a person administrating a business. You need an office to deal or communicate with clients, solve their complaints, distribute salaries or accumulate bills. It’s all good.
3. Do You Use The Office Daily?
The third rule states that a remote worker must actively use the office space regularly. For example, you have built a small home office. But your job needs you to move from one place to another continuously.
An agent who visits different clients daily and provides consultation might not use the home office every day. If you enter the home office once a week for collecting a paper or something it means you are not an active user. You automatically lose the chance.
What Type Of Home Office Expenses Are Deductible For Renters?
When you are the house owner, it’s easy to calculate the deductible expenses. The IRS authority clarifies that any utility or repairing expense you rendered for the home office portion of your house is tax deductible. You can simply calculate the percentage of your total home used as an office (suppose 10%), and attach that to any home-related expenses.
For example, monthly mortgage interest, insurance, repairing, improvement, etc. But what’s the rule for renters since they don’t pay any mortgage? Well, the main tax-deductible expense is the rent you pay to your landlord. Apart from that if you have renter’s insurance, repairing expenses, utility bills, internet or secondary phone bill, etc are also suitable for a tax cut.
Just attach the same percentage we mentioned before to each of these expenses and you get the final tax-deductible amount.
Note: You don’t get a tax cut for using the primary phone in your home for office purposes. It’s only doable if you get an exclusive phone and set it inside the home office to attend to your clients.
Can You Expect Home Office Tax Cut If You Own The Rental Property?
Okay, so we have discussed the requirements a renter has to fulfill in order to receive a tax break. But what if you own the rental property? For example, you rent the property to tenants. It can also be a hotel or inn. But at the same time, you have spared yourself space for an office.
In that case, are you eligible to get the write-off or not? Well, it’s not so simple to answer that. Let’s find out below.
1. Investment VS Business
The first thing you have to verify is whether you treat the property as an investment or business. If the property is an investment (renting it to tenants), your home office wouldn’t be acceptable. Simply because the office doesn’t satisfy the criteria of “principal use” anymore.
The tax auditors assume you don’t have any practical purpose within the office except collecting rent payments. But if you can convince the authorities that your rental property is used for trade & business, you can get away with it. Then, the home office will seem important for administrating or overseeing the trade.
For example, show some services you provide to the tenants to make it seem like you are running a business. It can be providing a maid or maintenance service. That enables you to claim that the home office is essential to dispute your renter’s complaints, provide services, oversee the staff, etc.
2. Running Multiple Businesses
Do you use the home office on your rental property to run several businesses? Well, we have bad news for you. IRS requires you to fulfill the “home office tax cut criteria” for each business you register. Suppose, you administrate the property from your home office. At the same time, you use the office to work remotely for an employer.
In that case, the first job would satisfy the criteria but the second won’t. Hence, you are disqualified to receive any tax break even for the first one.
3. The Downside Of Self-Employment Tax
It’s not all fun getting approved for a home office tax break for your rental property. If you are not careful with what you show in the tax return, it can trigger another tax category called the self-employment tax. The rate can be as high as 14.43% of your federal income tax. Looks like a nightmare, doesn’t it?
So, we urge you to carefully check the factors that push you in the self-employment direction. For example, if you provide simple services like trash management or repairing damage, it won’t count.
But if you go beyond that limit by providing stuff to your tenants or customers for maintenance services, or installing luxury tools inside the property for extra comfort, you will easily trigger the “self-employment” tax. If that chapter opens, we are afraid the benefit you are hoping to get from a home office tax cut will fade away. The money coming into your pocket will be lower than the new tax you have to pay.
Note: As a rental property owner, you are eligible to deduct tax for the expenses you bear to maintain the home office. But it has to fall under the “improvement category.”
How Do You Calculate The Home Office Tax Deduction On Rental Property?
Calculating your home office tax deductibles for rented property is pretty easy and the same as owning it.
1. The Simple Method
Workers who hate complications can use this simple method to calculate their tax cut. In this method, you have to assign $5 to each sqft of your home office. It doesn’t matter whether it’s rented or not.
Take a look. Measure the area of your workspace. If it’s 120 sqft, multiply $5 by it. So, you get about a $600 tax break in total. It might be less or more than what you can save by tracking each office expense. The good news is that IRS gives you full freedom when it comes to selecting either of these methods.
Finally, you have to claim your break on Schedule C.
2. The Percentage Method
This method is comparatively tedious and a bit difficult for average people. Here, along with the home office area, you also need to measure your house/property as well. Now, calculate how much space (in percentage) the workspace is taking away from you. For example, for a 1200 sqft house with a 120 sqft of office, the percentage we get is 10%.
That’s the key. Now, keep a record of every expense you pay for the house. It can be the rent, insurance, maintenance, etc. But at the end of the year, you have to deduct 10% from each of these expense sectors. Since the home office is consuming 10% of the house, you only have to pay tax on the remaining 90% area.
3 Tips To Save You More Money While Filing Tax Returns
Most people let go of a lot of their hard-earned money because they fail to convince the auditors. It’s all about thinking ahead and making the right decisions. Here are three tips that’ll help newbies to file their tax returns.
1. Keep The Expense Record
No matter whether you pay rent for the property or own the rental property, there’s no escaping recordkeeping. Yes, the more records you keep of your bills/expenses the more money you can demand. Also, it will save you the trouble of complicated investigations by the auditors.
From now on, whenever you spend money for your home office be it a simple repair or buying a cabinet, collect the receipts. Dedicate a separate drawer for those small receipts throughout the year.
2. Don’t Rely On One Method Only
While calculating the home office tax cut, you will be tempted to stick with one method. For some people, it’s the percentage method while some might like the simple one. But the ideal thing to do is mix and match the methods.
If you are using the simple $5 per sqft method this year, go for the percentage method the following year. That way, you can be sure which method saves you the most amount of money.
3. Get A Lawyer
Finally, there’s no substitute for a lawyer who understands the best deal for you. It will be hard for you to know all the “grey areas” existing in the tax regulations and how you can use them to your advantage.
We highly suggest investing in a lawyer’s consultation before filing a tax return.
Before You Go!
We know that tax is not the most interesting thing in the world. But no one is going to give you the money you deserve if you choose to ignore it. There’s a possibility that your request will be declined or denied by the authorities like many others. But it’s still worth giving a shot.
Check out our other explanation of writing-off home office if you need more clarification.