Rentals to an Employer

Employees need to be careful when arranging compensation from employers for home offices to qualify for all of the deductions that they expect. Letter Ruling (TAM) 200121070 provides insight into the Service's position on Sec. 280A(c)(6). Under this provision, a taxpayer cannot take deductions for business expenses connected to rental income for a home office used exclusively for business as an employee at an employer's convenience. The unwary taxpayer can still take mortgage interest, property tax and casualty loss deductions related to the home office, but cannot deduct additional expenses connected to the rental income, including business expenses, depreciation and business casualty losses.

Normally, Sec. 280A(c)(1) allows a taxpayer to deduct expenses allocable to the portion of a home used exclusively for business on a regular basis. Also, Sec. 280A(c)(3) allows the taxpayer to deduct expenses attributable to the portion of a home rented out. However, to curb potential abuses inherent in transactions that are not at arm's length, Congress disallowed business deductions for employees with home offices rented to employers. Sec. 280A(c)(6) states:

Treatment of Rental to Employer. Paragraphs [c](1) and [c](3) shall not apply to any item which is attributable to the rental of the dwelling unit (or any portion thereof) by the taxpayer to his employer during any period in which the taxpayer uses the dwelling unit (or portion) in performing services as an employee of the employer.

Clearly, Sec. 280A can undermine taxpayers involved in legitimate business transactions. The IRS issued the TAM in response to an inquiry from a taxpayer who could not find a place on the tax forms to claim business expenses and depreciation attributable to rental income from an S corporation of which the employee was the sole shareholder and employee. However, the TAM helpfully points out that an employee can deduct business expenses related to a home office when he receives reimbursements included in salary instead of rent payments.

Indeed, it seems that employees with home offices should avoid renting them to employers and instead arrange to receive reimbursements, whether included in salary or in some other manner. Taxpayers do not have to report reimbursements included in salary on Form 2106, Employee Business Expenses, and do not reduce the home office expenses transferred to Schedule A, which includes business expenses in the absence of rental income. Employees with Social Security wages below the tax ceiling can arrange to receive reimbursements separate from salary. For this, the employee need report as earned income only the excess of the reimbursements over home office expenses (including business expenses). Either way, employees who arrange to receive reimbursements instead of rent from their employers can obtain comparable compensation while qualifying to take all expected deductions on a home office (including business deductions, depreciation and business casualty losses).

From Peter Truelove, CPA, Brown, Dakes, Wannall & Maxfield, P.C., Fairfax, VA