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Lessons from the Tax Court: Rent for home office

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in Small Business Tax,Small Business Tax Deduction Strategies

The tax law generally allows a business to deduct “ordinary and necessary” expenses. Therefore, you may be able to write off rental payments you make for office space—even if you’re the landlord and the place of business is your home.

But this setup between “related parties” could raise eyebrows at the IRS, so be prepared to show that the rental is legit. In a new case, the taxpayer failed to convince the Tax Court. (Ng, TC Memo 2018-14, 2/5/18)

Facts: The taxpayer, a physician, was the sole owner of an incorporated medical practice in California. In 2012 and 2013, had a contract to perform work for a Los Angeles hospital.

The taxpayer used the entire second floor of his home exclusively for his medical practice. It had a separate external entrance with alarm panel access, a converted master bedroom, a den, a lavatory and a furnace area.

In this space, the taxpayer performed administrative tasks for the practice, such as remotely accessing the hospital’s medical records to complete notes on patients he had treated at the hospital. He also used the office space for continuing education and medical board certification activities.

But the taxpayer never saw any patients at his home. The only people besides the taxpayer who ever ventured upstairs were his paid assistant and malpractice defense attorneys he occasionally met with.

During 2012 and 2013, the medical practice deducted the mortgage interest payments for the residence, roughly $30,000 a year, that were designated as rent.

A connection between a lessor and lessee doesn’t necessarily invalidate a valid lease agreement. However, the courts will take a close look at all the circumstances to determine whether the payments actually constitute rent.

Outcome: In this case, the taxpayer didn’t produce any evidence of a written rental agreement or other records to support his contention that the outlays were rent payments. Nor did the practice report any rental income on its returns. Case closed: The deductions for “rent” were denied.

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