Is business rent tax deductible?
Yes, business rent is tax deductible under qualifying circumstances. That’s a good thing too, since rent is often among an organization’s largest overhead expenses.
As part of our ultimate guide to business expenses and tax deductions, this article will run through different types of rental tax deductions, who qualifies, what to avoid, and ultimately how to claim the deduction.
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
We covered the complexities of the following requirements in our home office deduction guide. But in short, here are the qualification requirements:
- The office is your principal place of business
- Used regularly for business
- Used exclusively for 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.
Once a business is certain they qualify, there are two methods of calculating the deduction:
Real Expense Method
To use this method, first record and tally your home’s cost. This includes rent, utilities, and upgrades to your office space, but it excludes things like groceries or upgrades to unrelated areas of the home.
Next, find the proportion of your home the office occupies and apply this ratio to your home costs; this is the value of the real expense method deduction.
Simplified Method
While the real expense method often produces a higher deduction, the simplified method is more convenient. Each square foot of office space is worth a $5 tax deduction, up to 300 sq. ft.
Traditional Office Space
Unlike the home office deduction, conventional office space is 100% deductible. This includes 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 stipulations 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 rent to one another, such as when two LLCs owned by the same individual or a family member. 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
The rules are slightly different since these companies spread ownership expenses across multiple individuals. 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 member may deduct 25% of the cost of renting an office.
Can You Write Off a Coworking Space?
Yes, businesses don’t need to rent out entire offices to use this deduction. Renting a coworking 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 visa 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.
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.
Travel Accommodations
This may not immediately come to mind when considering rental expenses, but a short-term stay at an Airbnb or hotel for business also counts as a travel expense deduction. Assuming you meet the IRS definition of a qualifying business trip, the cost of lodging while traveling is fully deductible.
We cover this topic in detail in our travel expense deduction article. Still, in short, the requirements for writing off lodging expenses while traveling are as follows:
- The trip lasts longer than a day but less than a year
- Individuals travel from their home city or “tax home”
- They work regular hours while traveling
There are special rules for traveling abroad and deducting travel expenses that don’t involve lodging. Be sure to read our travel expense deduction guide for more detail.
Deductible vs. Nondeductible Rent
Sometimes, it’s easier to know what is allowed by knowing what isn’t.
We’ve put together a comprehensive overview of non-deductible business expenses in the past, but when it comes to rent in particular, here’s what 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 go a long way toward 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 commingling 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.
For more information, we’ve outlined a step-by-step guide for business owners who want to learn how to track business expenses.
Maximize Your Business Rent Deductions: Tips and Strategies
Business tax is a burden on profitability no matter how you cut it. So, if you’re going to pay rent for your business, you might as well get the most bang for your buck come tax time, right? Here are some clever (and legit) ways to maximize those rent deductions:
1. Negotiate Tenant Improvements
When leasing a new space, try to get your landlord to agree to some improvements. Maybe fresh paint, new carpeting, or a bathroom update if necessary. If they bite, those improvements could be deductible as part of your rent. It’s like getting a mini-makeover for your office and a tax break. Win-win! Ensure these terms are clearly outlined in your lease agreement to support your deduction claims.
2. Sublease Unused Space
If you have extra office space, consider subleasing it to another business. Why not sublet that extra corner to the startup next door? You’ll still get to deduct all the rent you pay, plus you’ll have some extra cash coming in from your new “tenants.” Just ensure your lease allows it, or you might end up with an angry landlord and a lot of explaining.
3. Explore Sale-Leaseback Arrangements
If you’re a business owner who owns your commercial property, a sale-leaseback is a clever move where you sell your property to an investor and then lease it back for use for your business. The sale-leaseback allows you to convert your non-deductible mortgage payments into a fully deductible rent payment, and the cash that used to be tied up in real estate is now unchained and can be used to reinvest into your core business. It’s a complex transaction with long-term implications, so you should consult financial and legal advisors before taking action.
4. Time Your Rent Payments Strategically
If you are a cash-basis taxpayer, you have some flexibility in timing expenses for tax purposes. Say you pay January’s rent in December. You get an extra month of deductions for the current tax year. This can be helpful if you have a high-income year and need higher deductions. Of course, you don’t want to push too much of your expenses into one year if that will leave you short on deductions the following year. You should always keep your overall tax situation in mind. Talk to a tax pro to determine if this is right for you.
5. Review Your Lease for Hidden Rental Expenses
Look at the fine print of your lease agreement. Some of your costs, such as property taxes, insurance, or common area maintenance fees, might be hidden in the rent. These ‘triple net’ expenses – a standard naming convention for commercial leases – are partly deductible as additional rent. You might boost your total rent deduction by identifying and correctly classifying these expenses. Go over your lease with a fine-toothed comb, or hire a real estate attorney to review the agreement and advise you on what you can legitimately claim.
6. Consider Co-working or Flexible Office Options
Co-working spaces and flexible offices offer a flexible, low-cost alternative to leasing. You might be able to sign up at a lower cost and for a shorter term. You can usually deduct all payments for these spaces as rent. Services like utilities, internet, and the like are often included in the quoted price, which makes it easier to track your expenses and might increase your deductions. You might want to use such an arrangement if you’re a start-up, a small business, or a company just testing out a new market.
7. Track Personal Use Meticulously
If you spend even some of your time in your business space on personal matters, keeping precise records of your personal use is essential. The more precisely you know your deductible business use, the better you can allocate your expenses and the more you can take as a deduction. For instance, if the space is used 10 percent of the time for personal purposes, you can deduct only 90 percent of the rent. A log or calendar of space usage can help substantiate your calculations should your return be audited. It would be best to keep it above board: honesty pays off. While you want to take all the deductions you can, there is such a thing as telling the truth.
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; they’re among the largest business expenses and have considerable potential for a tax deduction.
There are three major rental expenses: home offices, traditional offices, and travel accommodations. We hope this guide has helped illuminate the deduction requirements and inform business owners of potential mistakes to avoid.
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