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.
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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 while excluding 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.
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, 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 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.
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. 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 as well as deducting travel expenses that don’t have to do with 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.
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.
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.
To anyone considering preserving their time by moving from DIY accounting to outsourcing, indinero’s 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.