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Q: My wife and I own a coffee shop that operates as an S-Corp. We're both officers of the corporation. Because we have limited space at the shop, I use my two-car garage at home for active inventory storage, and my wife does bookkeeping in our spare room. Can we deduct this use of our personal property for business?
-- R.S., California, Md.
A: Technically, you may take a deduction for your garage and spare room if you employ them exclusively and regularly for administrative or management activities. However, experts advise that you tread cautiously. Such deductions tend to invite IRS audits.
In general, utilizing a portion of your home on a regular basis exclusively for business can entitle you to a home-office deduction on your personal tax return. Expenses related to the business use of the home for employees are deducted on Form 2106 and Schedule A, subject to the 2% adjusted gross income (AGI) limitation, says Brad Hall, managing director of Brad Hall & Co., an accounting firm in Irvine, Calif.
LEGITIMACY TEST. Deductible expenses include an allocable portion of mortgage interest, taxes, insurance, home repairs and maintenance, utilities, and depreciation, he says.
However, you need to meet one of the main tests for legitimacy of the business-in-the-home deduction: That your home office constitutes your principal place of business, where administrative activities and client meetings take place.
In your case, the fact that you already have a principal place of business -- the retail coffee shop -- and that you likely also use your garage and spare bedroom for such things as personal storage, car parking, and guest housing can present problems.
FREE RIDE Another potential obstacle is that most business owners form corporations in order to protect personal assets from business creditors and claims. When you commingle business and personal assets, you could expose to liability traditionally safe assets. Courts sometimes "pierce the corporate veil" by holding business owners personally responsible for business claims when the owners, through their actions, failed to respect the entities' separate existence, says Hall.
You should also remember that an S-Corp still qualifies as a corporation, separate and distinct from its owners. Accordingly, using personal property for the corporation in essence gives your business free rent for storage and bookkeeping space, which the IRS could deem taxable. Plus, if you decide to sell your home in the near future, you might face tax implications if you have been claiming business deductions on the house.
Talk to a knowledgeable accountant about these issues and any others he or she raises. You may find that the hassles and potential problems of filing a home-office deduction outweigh the money you'll save on your personal return. In short, you might play it safer by renting space in a storage facility or office park close to the coffee shop.
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