Question: I have a lake house which I occasionally rent to my corporation for business use. Am I still allowed to both exclude from tax the rental income I receive and have the corporation deduct the rent paid?
Answer: You certainly can do so as the law has not changed in this regard. The exclusion from tax of rental income from your home is subject to certain limitations. Similarly, there are some overall rules which impact the deduction of business expenses. However, if you properly structure the rental arrangement, the rental income paid by your corporation can be deducted and the rental income you personally receive can be excluded from your taxable income.
The starting point in this case is recognizing that business expenses of your corporation are deductible if they are ordinary and necessary to carry on the company’s trade or business. An expense is ordinary if it is customary in the particular business in which the corporation engages. An expense is necessary if it is appropriate or necessary in the conduct of the business. Routine expenses such as payroll, rent, insurance and a whole host of common expenses are deductible. Generally speaking, a company expenditure for a retreat designed to further company business such as strategy sessions or planning meetings fall within this category. Of course, amounts spent for rent must be reasonable and must not exceed market rents for similar properties.
There is a limited exception which allows rental income to be excluded from tax. The Internal Revenue Code provides that income received from a taxpayer’s rental of a residence will not be subject to income tax if the residence is rented for not more than 14 days during the taxable year. Any rental in excess of 14 days will cause all of the rental income to be taxed to the party leasing the residence.
Your reference to the word “still” suggests that you may be familiar with a recent Tax Court case which challenged rent expense deductions under a similar fact pattern. In the recent case, the court sided with the IRS in disallowing rent expenses paid to the shareholder of a corporation for a series of meetings that occurred in the shareholder’s home. The factors relied upon by the court included the absence of documentation substantiating the business conducted at the residence and the parties’ failure to establish an appropriate rental rate for the shareholder’s home.
Despite the court holding, the recent case provides a blueprint for reaping tax benefits from these types of arrangements. The rental arrangement should be reflected in a written lease between you and your corporation. You should investigate market rental rates and determine a rate that is appropriate for the residence being rented and the time period of the rent. You should also document the specific business being conducted at the meetings taking place at the residence.
Other tax rules should be considered if food will be served and/or entertainment will occur during the course of the retreat. There are limitations on deducting expenses for food, beverage and entertainment expenses. These rules may limit a company’s tax deductions for amounts expended.
Self-rentals present an interesting opportunity for business owners and their companies. There are few circumstances where income received is not subject to income tax. Short-term rentals are one situation where income received can be excluded from income tax. Anyone embarking on an arrangement like this should take the time to establish the viability of the arrangement and properly substantiate the amounts paid.
The Tax Corner addresses various tax, estate, asset protection and other business matters. Should you have any questions regarding the subject matter or if you have questions, you want answered, you may contact Bruce at (312) 648-2300 or send an e-mail to email@example.com.