CARL WATTS & ASSOCIATES

June 24, 2013



Any amount you pay for the use of property you do not own is rent. The question is: “Under what circumstances are you allowed to deduct the rent you pay?”

In general, you can deduct rent as an expense only if the rent is for property you use in your trade or business. If you have or will receive equity in or title to the property, the rent is not deductible.

You can claim a rent deduction on your Federal taxes if the rent is for a facility used for business. If you are a business owner, the rent on an entire retail business, storage facility, or other business-related structure is considered a business expense, and it is deductible.


If you run a home business you may be able to deduct part of the rent on your home if you can show that a certain area of the home is used for the purpose of conducting business. The IRS has specific guidelines about calculating tax deductions for business use of a home, but the key thing for you to know is that you can only deduct a percentage of the rent, not the entire rent for the home.

You don’t have to be a business owner or self-employed to be able to deduct the business use of the rent you pay for your home; you may very well be an employee working from home.


To be able to deduct your rent as an employee business expense you must have a certain space in your home dedicated as your principal place of work that you use regularly and exclusively for your employer’s convenience (that means your employer requires you to work at home, you don’t work at home simply because it is helpful and convenient for you).


You cannot take a rental deduction for unreasonable rent. Ordinarily, the issue of reasonableness arises only if you and the lessor are related. Rent paid to a related person is reasonable if it is the same amount you would pay to a stranger for use of the same property. Rent is not unreasonable just because it is figured as a percentage of gross sales.

To be able to claim expenses for the business use of your home, you must meet both of the following tests:


  1. The business part of your home must be used exclusively and regularly for your trade or business.
  2. The business part of your home must be:

a. Your principal place of business, or

b.

A place where you meet or deal with patients, clients, or customers in the normal course of your trade or business, or

c.

A separate structure (not attached to your home) used in connection with your trade or business.

Your home office qualifies as your principal place of business if you meet the following requirements.

  • You use the office exclusively and regularly for administrative or management activities of your trade or business.


  • You have no other fixed location where you conduct substantial administrative or management activities of your trade or business.


If you have more than one business location, determine your principal place of business based on the following factors.


  • The relative importance of the activities performed at each location.


  • If the relative importance factor does not determine your principal place of business, consider the time spent at each location.


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You can find more details about what you can deduct for the business use of your home in one of our previous newsletters.

To deduct your rent as an employee business expense you must use Form 2106.

If you’re on your own, you can deduct rent expenses on Schedule C.

You should also know that rent deductions or credits are available in certain states; some states permit taxpayers to deduct a percentage of their rent payments from their state tax returns, other states provide renters a credit depending on filing status and income level.

As a general rule, in order to qualify for a rent deduction, someone needs to be filing as the head of a household, and the rent involved must be rent used for a primary residence. The definition of “primary residence” can vary from state to state, so people who rent several properties may want to check with a tax professional to determine which property meets this requirement.

State-by-state information about rent reductions is available in the tax forms for individual states.

If you have rental income, such as from letting a house, flat, apartment, office, building etc., you are allowed to deduct legitimate property related expenses like: commissions or property management fees, advertising costs, cleaning, maintenance, and repair costs, homeowners insurance and HOA dues, real estate taxes and mortgage interest expenses, security deposits reimbursed to the tenant, and various other expenses, such as utilities, landscaping, garbage, and so forth.

As a landlord, you need to keep excellent records regarding cost basis, income, and expenses.

If your rental property has a net loss for the year, that loss is netted against the losses and profits of all your other rental properties for the year. If the grand total for all rental properties is negative (at a net loss), that rental net loss might be fully, partially, or not at all deductible against the rest of your income for the year as a result of the passive activity loss limitations.


Renting out real estate property is generally considered a passive activity, even if you devote a substantial amount of time to selecting the right tenants, repairing the rental unit, and inspecting the property for routine maintenance. Losses from passive activities are limited to offsetting passive profits.


For more details on loss from real estate rental please see our newsletter on this subject.

Income and expenses from real estate rental are reported on Schedule E of the Federal taxes, while Form 8582 is used to calculate passive activity loss limitations and to keep track of rental losses that accumulate each year for each property.


Landlording can be a risky business, so, if you are a landlord, you are encouraged to enroll professional help for adequate tax planning of your rental income and expenses and to determine the correct way to file your taxes and the proper deductions for your specific situation.