Yes, business rent is tax deductible under qualifying circumstances since it forms part of the organization’s main overhead expenses.
Table of Contents
1. Can business rent be claimed as tax deductible?
2. How to Write Off Rent as a Business Expense
3. When can you write off rent on a business trip?
4. Deductible vs. Non-deductible Rent
5. Documenting Rental Expenses
6. Conclusion
How to Write Off Rent as a Business Expense
The toughest part of claiming this deduction is navigating eligibility requirements and their respective deduction limits. Here’s what you need to know about the three most important ways to deduct rent as a business expense.
The Home Office Deduction
For many businesses, especially small startups and freelancers, a home office space is a common practice. It eliminates the extra expense of renting a separate office space outside of your home. When it comes to a home office, you’ll dedicate a portion of your home for business purposes. You may purchase a new desk, or office chair, and even embellish your home office so it elicits a pleasant work environment.
In a nutshell, though, you’ll be able to claim a home office as long as you have a workstation that:
- Is regularly used for work
- Is exclusively used for work
- Is your principal place of business
This means that despite the rising importance of remote work, W-2 employees are excluded from eligibility. A recent change in tax law eliminated this deduction. The home office deduction is a common source of tax write-offs for self-employed people.
Once a business is certain they qualify, the following are the two methods of calculating the deduction:
Real Expense Method
Under this method, the taxpayer is required to first record and tally your home’s cost. The cost shall include rent, utilities, and improvements to your office space while excluding things like groceries or improvements to unrelated areas of the home.
The next step is to identify the proportion of your home which is occupied by business and apply the said proportion to your home costs.
Simplified Method
The simplified method is more convenient. Each square foot of office space is worth a $5 tax deduction, up to 300 sq. ft. The Simplified method results in lower tax deductions in comparison to the Real Expense Method.
Traditional Office Space
This includes expenses incurred for conventional office space comprising of rent, utilities, repairs, costs for obtaining or terminating a lease, and upgrades to the space paid for by your business. However, there are some important points to keep in mind.
Rent Must Be Reasonable
“Reasonable” is a subjective phrase. However, as far as the IRS is concerned, reasonable rent is synonymous with being charged a market rate. This rule is the IRS’s attempt to pre-empt individuals who avoid taxes by shifting income into exorbitant rent.
This rule typically arises when related parties, such as when two LLCs owned by the same individual or a family member, rent to one another. The IRS pays close attention to such situations, as they create the opportunity to shift income.
No Rent-to-Own Arrangements
Sometimes payments are listed as “rent” when they’re really for the purchase of the property. If at least part of the payments made as “rent” is applied toward the purchase of the property, or if the contract entitles the renter to acquire the property advantageously under fair market value, this is known as a conditional sales contract and is not deductible as rent.
However, conditional sales contracts may be deductible under depreciation rules.
Special Rules for Partnerships and Multimember LLCs
Since these companies spread ownership expenses across multiple individuals, the rules are slightly different. In this case, only the proportion of the rental expenses an individual is personally responsible for may be deducted. That means in a four-member LLC, each may deduct 25% of the cost of renting an office.
Can You Write Off a Co-working Space?
Yes, businesses don’t need to rent out entire offices to use this deduction. Renting a co-working space or even a studio are both fully deductible business expenses.
One or the Other: Traditional Office or Home Office
Since the home office deduction requires it to be your principal place of business, entrepreneurs may only deduct either a traditional office or a home office. Not both.
If you have a traditional office during the year but switch to working from home, or vice versa, you may take a deduction corresponding to the time spent working from each location.
For instance, if you worked from home for six months and rented an office the other six, then six months of home expenses (per IRS limits) would be deductible in addition to six months of office rent.
When can you write off rent on a business trip?
The rules on work-related travel write-offs are pretty clear. If the purpose of the trip was for business, you can deduct the cost of your lodging, whether it’s an Airbnb, sublet, or motel.
The IRS has some additional rules for determining whether your trip counts as work-related. You have to:
- Work regular hours
- Be at least 100 miles from home
- Be gone for less than a year
Rules for Rent Paid Upfront
Business owners may only deduct rental expenses for the current year.
For example, if someone paid for a five-year lease up front, they would have to spread that deduction over each of those five tax filing years. Front-loading the tax deduction to a single year is not allowed.
Deductible vs. Nondeductible Rent
Important points to keep in mind:
- Deducting personal rent is not permitted
- Deducting non-business rent is not allowed
- No unreasonable rent; what’s paid must be market rate
Avoiding these three nondeductible rental expenses will help in protecting you during an audit.
Documenting Rental Expenses
It’s best to document any expense used to claim a deduction properly. This is important for audit risk management and makes good business sense; strong record-keeping is key to visualizing cash flow and future decision-making.
In short, we recommend systematizing and automating record-keeping to minimize mistakes and time spent on accounting.
The first step is creating separate business and personal bank accounts. This helps you avoid mixing funds.
From here, the easiest way to automate is to use bookkeeping software that integrates with your business bank accounts. The program pulls everything into one place so that all business owners have to do is review somewhat regularly, categorize expenses, and look for anomalies.
Conclusion
Business owners work hard for their revenue and deserve to keep every dollar that’s rightfully theirs. Understanding and properly claiming rental expenses is a great place to start; it’s among the largest business expenses and has considerable potential for a tax deduction.
We hope this guide has helped illuminate the deduction requirements and inform business owners of potential mistakes to avoid.
To anyone considering preserving their time by moving from DIY accounting to outsourcing, Profits View online bookkeeping services are here to help. Let us do what we do best so that you can return to doing what you do best.