Self-Rental of Home Office for MMLLC

[jsamans]

A husband-wife multi-member LLC taxed as a partnership has an operating agreement that requires each member to maintain a home office. Presently, the members claim the expense of these home offices as UPE on their joint return (1040). The husband (who owns their current home solely in his name) wondered about the value of renting a portion of their home to the LLC in lieu of the UPE home-office arrangement currently in place.

I understand that there are issues associated with self-rental such that any net income is treated as active, while any net loss is treated as passive. However, the FMV is very close to break-even, and because the LLC is a pass-through entity in which both members materially participate, net income from any source associated with the LLC is already active. Also, the couple is unconcerned with the accumulation of any passive losses that may result, because they have other rental property that is anticipated to begin generating passive income in the next few years.

Taking those concerns off the table, therefore, I'm really wondering about two things:

1. Is there any financial gain in making this change? (There doesn't seem to be: the same expenses get paid, and the amounts end up subtracted from business income before application of self-employment tax.)

2. If there a non-financial gain? For instance, if the space is rented on a square-footage basis rather than in terms of specific rooms, is the home-office burden of maintaining exclusive and regular use replaced by the need only to meet the requirements of the lease (such as making the space "available on demand")?

[taxea]

Do they file a joint individual return? Do they file separate LLC returns or are they engaged in the same business? Take the office expenses on 2106 collectively or for each....not as a business rental

[jsamans]

Do they file a joint individual return? Do they file separate LLC returns or are they engaged in the same business? Take the office expenses on 2106 collectively or for each....not as a business rental

Yes, they file jointly. The LLC is taxed as a partnership so they file Form 1065 and receive K-1s for their 1040. 2106 is for employee expenses; they're members of the LLC, not employees, so the home-office deduction is handled on Schedule E as an unreimbursed partner expense (required by their operating agreement).

[taxea]

See Publication 587

[ATSMAN]

Sch E Part II

You will need to do the OIH worksheet in pub 587 then go to sch E part II.


Unreimbursed Partnership Expenses

You can deduct unreimbursed ordinary and necessary partnership expenses you paid on behalf of the partnership on
Schedule E if you were required to pay these expenses under the partnership agreement (except amounts deductible
only as itemized deductions, which you must enter on Schedule A).
Enter unreimbursed partnership expenses from nonpassive activities on a separate line in column (h) of line 28.
Do not combine these expenses with, or net them against, any other amounts from the partnership.

If the expenses are from a passive activity and you are not required to file Form 8582, enter the expenses related to
a passive activity on a separate line in column (f) of line 28. Do not combine these expenses with, or net them against,
any other amounts from the partnership. Enter “UPE” in column (a) of the same line.

[jsamans]

You will need to do the OIH worksheet in pub 587 then go to sch E part II.

Right. That's how it was done last year: their partnership agreement has that provision, and they claim the value from the worksheet as UPE. The husband was wondering whether renting the space to the partnership would relax the requirement for exclusive use of space, so that the partnership could establish policies that made the space primarily used for business with provisions that okayed limited person use.

I've not been able to find anything that addresses that. Most info on renting to your business deals with an employee relationship, which is true even for S-corps but isn't for partnerships.

[ATSMAN]

I see where you are going with this but this part of the law concerns me:

Exceptions to Exclusive Use

You do not have to meet the exclusive use test if either of the following applies.
You use part of your home for the storage of inventory or product samples (discussed next).
You use part of your home as a daycare facility, discussed later under Daycare Facility.With the exception of these two uses, any portion of the home used for business purposes must meet the exclusive use test.

So if the LLC agrees to allow a partner to use the OIH for some incidental personal use and it is documented as you state, then it may be very difficult to defend in an audit.

Let's face it, from a practical perspective most taxpayers with an OIH have used it for some incidental personal use. Say when you have an unexpected guest overnight or your wife throws you out of the bedroom!

[jsamans]

Yeah, I saw that. The thing is, both the exclusive and regular use as a principal place of business and the regular basis for certain storage use are separate bases for qualification in Pub 587, and rental use (for which it points to Pub 527) is another separate bullet.

What the husband is thinking is that once he's entered into a lease with his company, the space is officially the office of the company, which would mean that, as is true for commercial space, how the company chooses to allow its space to be used becomes a function of what the lease allows and what the company's policies say. I'm not saying I agree, per se - but I haven't been able to find anything that really addresses it when there's no employee-employer relationship. I mean, it's self-rental, no doubt, but it's no longer a home office if there's a lease.

But you make the best point, I think: the fact is that some minimal degree of non-exclusive use probably exists in all same-room home offices, and the level of hassle they'd be adding to track the rent payments and such just to make an argument that might well be denied by an auditor isn't worth the effort. :-)

[ATSMAN]

Unless I find some case law, I don't try to go aggressive and be the first one to find out the hard way. I avoid agreeing with a client who is "thinking out loud", unless I have some basis to agree based on case law or example.

Some taxpayers are very imaginative and once you start agreeing with them, you lose sight of the objectivity and it could come back to bite you.