Deducting Office w/Sch E income

[AZ-Tax]

Taxpayer (new client 2011 TY) has 10 rental properties and has been filing Schedule E on each rental since rental was placed in service. In 2011, taxpayer purchased a house used 100% as office to manage his rentals. Keep in mind he has a separate house for his residence. For the office I first thought a Schedule C but he is NOT SE. A Sch E but its neither a Com or Res rental. Divide the cost of the office including depreciation equally among the 10 rentals.... Your thoughts?

[FEDUKE404]

Creative approach

Interesting scenario.

I might have a problem justifying the entire house (to include bedrooms/kitchen/dining rooms/bathrooms/etc) as a "business expense" but if you can navigate that hurdle I assume the most logical approach is to allocate something proportionately among the actual ten rentals, perhaps via gross income of each?

Is there any way this guy is approaching a "real estate professional" level, i.e. Sch C with inventory??

Also the house likely cannot be depreciated as a "residential unit" but more appropriately as a "commercial building." That might complicate things a bit. Of course, there will be no rental income for the "office" but that may well change. I would bet a nice lunch that, at some time in the future, the "office" might well turn into another "rental" property.

FE

[AZ-Tax]

Probably not Real Estate Professional

Interesting scenario.

I might have a problem justifying the entire house (to include bedrooms/kitchen/dining rooms/bathrooms/etc) as a "business expense" but if you can navigate that hurdle I assume the most logical approach is to allocate something proportionately among the actual ten rentals, perhaps via gross income of each?

Is there any way this guy is approaching a "real estate professional" level, i.e. Sch C with inventory??

Also the house likely cannot be depreciated as a "residential unit" but more appropriately as a "commercial building." That might complicate things a bit. Of course, there will be no rental income for the "office" but that may well change. I would bet a nice lunch that, at some time in the future, the "office" might well turn into another "rental" property.

FE

His is an 80 yr old taxpayer with most of his income coming from SS and taxable interest. No plans to add anymore rentals. His is NOT a realtor.

[Gary2]

"Realtor", of course, is a trademarked name that may only be used by authorized member of a particular professional organization, and is unrelated to the tax concept of "real estate professional."

[FEDUKE404]

House as an office??

"Realtor", of course, is a trademarked name that may only be used by authorized member of a particular professional organization, and is unrelated to the tax concept of "real estate professional."

Hopefully anyone on these boards who is managing a tax return dealing with (at least) ten rental properties already has a full understanding of the IRS issues related to "real estate professional."

And, then again, maybe the Realtor® distinction does need to be made.

I'm still curious as to having a "house" as an office. More than likely an 80 YOA "rental property owner" does not have staffing/storage/public area/etc issues that could justify an entire residential unit as a Sch E "office expense." Kinda makes you wonder if house #11 could not be rented and.....became an office!! The companion observation would be HOW did he (apparently) previously manage the 10 homes......without an office??

Sorry to be so skeptical, but in these days I just do not like the thought of the IRS sniffing around any tax returns I prepare that might not pass the overall smell test.

FE

[joanmcq]

Are they 10 large apartment houses? Or 10 single-family residences?

Does not even come close to passing the smell test for me.

And even RE professional doesn't report on a Schedule C. Schedule C is only if the rentals are short term and significant services are provided. Think 'hotel'.

[Lion]

Does he have a grandchild living in that house?

[AZ-Tax]

Answers & more

FEDUKI404 – When I asked how he managed all these yrs w/o an office, he replied it was not that much of a problem with just a handful of rentals but he added quite a few the last couple yrs. He uses it to store items when he and his handyman are not using it like ladders, paint, tools, etc. He says all the rooms are being used for either for office, storage, etc. except for kitchen and bathroom.

Joancq – they are 10 individual residential houses.

Lion – nobody lives in the house that he is claiming as his office.

Taxpayers 2010 tax return prepared by the previous preparer list TP as an “active participate” but NOT “material participation” on all Sch E rentals.

[taxxcpa]

Rental office

Taxpayer (new client 2011 TY) has 10 rental properties and has been filing Schedule E on each rental since rental was placed in service. In 2011, taxpayer purchased a house used 100% as office to manage his rentals. Keep in mind he has a separate house for his residence. For the office I first thought a Schedule C but he is NOT SE. A Sch E but its neither a Com or Res rental. Divide the cost of the office including depreciation equally among the 10 rentals.... Your thoughts?

If he uses it exclusively as an office, I would deduct it but add a disclosure as to the situation. I would allocate the cost among the ten houses based on either square footage or rental income from each.
I would follow the same rules regarding depreciation, etc. as you would for a home office for a business.

[oceanlovin'ea]

I think I would be inclined to deduct the operating expenses of the house he uses as an office. I would allocate the cost of utilities, taxes, insurance, etc but I don't think I would take an depreciation on the house.

If he rented an office space, he would have an expense for that. So instead he is using a house that he owns for the office. I feel operating expenses would be allowable.

Linda, EA

[Roberts]

I'd spread the cost between the rentals equally. Just because a rental property provides more rent or is larger doesn't mean it requires more time. Spreading it equally makes the most sense to me and avoids the implication you are possibly applying more cost to the most profitable and less cost to the less profitable.

I don't see why a house as an office is such an odd idea. MANY companies operate their businesses out of houses they've turned into commercial property. The only problem I could see is that they may say it doesn't qualify as commercial property so it can't qualify completely as an office but I'd doubt the IRS would care about that. As long as it is being used 100% as an office, I see no problems regarding the IRS.

I also think you should depreciate. If the office was in his residence you'd depreciate, why not an office in its own structure? If he bought a commercial property to run his business out of, you'd depreciate it.
JMO.

[Lion]

Is it zoned as commercial space?

[AZ-Tax]

Answer to Lion

Is it zoned as commercial space?

Answer is NO to the commercial question

[Lion]

So, your client should not be using the building for commercial purposes.

[Gary2]

So, your client should not be using the building for commercial purposes.

That would depend on the precise zoning laws. I haven't read the zoning bylaws of my new town, but my previous town had no prohibition against home offices in residential zones as long as there was no outside appearances of business, and no significant business traffic. I recall one case where a septic truck was eventually prohibited, but a general contractor with nothing but a pickup truck and a shed used to store equipment would have no problem with a home office. Certain specific businesses with customer's on site would even be allowed in an otherwise residential zone, though I don't recall if they required a special permit.

The definition of business for tax purposes has very little do to with the definition of commercial use for zoning purposes.