Form 8829, which shows the total and business square footage of the home and you also show the direct and indirect expenses. Direct expenses benefit only the business part of the house (such as a repair to an air conditioner unit in the business room). Indirect expenses are mortgage interest, real estate taxes, insurance, home repairs and maintenance, utilities, depreciation, security system, casualty losses, etc.
If you have an incorporated business, you have some other options to filing Form 8829. You can have the business entity reimburse your for actual direct and indirect expenses. The company reimburses you personally for actual indirect expenses (utilities, insurance, cleaning, repairs, etc) but not for mortgage interest and real estate taxes (which are still claimed as itemized deductions on Schedule A) or depreciation. This is not income to you personally and is fully deductible by the company. You allocate the indirect expenses based on square footage used in the business compared to the total square footage. Doing this does not convert any part of your home to a “business property” so there is no depreciation recapture on sale.
Another alternative is having the business pay rent to you. The company has a deduction for the rent paid. You have income for the rent received and will need to allocate a part of your mortgage interest and real estate tax to Schedule E to offset rent income. You will also allocate the indirect expenses (as noted above) to Schedule E. You will also depreciate your home based on the square footage used by the business.
To the extent that the combined expenses are greater than the income, any loss will be treated as passive. Depending on your income level and the other investments you have, you may not be able to deduct the passive loss in the current year. Any passive loss that is limited in the current year can be carried over indefinitely for use against future passive income or when you dispose of the house in a taxable event.
By paying rent and creating a passive loss, you could be moving deductible mortgage interest and real estate taxes from Schedule A and deferring the benefit until later years, which may actually cause you to pay more in taxes in the current year.
If the rent paid is greater than the expenses, the income will be treated as non-passive. You cannot offset other passive losses with income from the self-rental. When you sell the home, you will need to recognize gain to the extent of depreciation deductions allowed or allowable.
Which option is best for you will depend on your unique tax situation. If you would like assistance in determining YOUR best option, please contact me at TeriK@fctcpa.com
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