Paying rent to yourself in a home office
Mar 25th, 2008 | By Kevin | Category: AccountingAt the PDXwi event last week, I was asked a very interesting question: Should a home based single-member LLC pay rent to the owner of the home–the same person– in order to avoid any “piercing of the veil” problems.
I found an answer to this problem in IRS publication 587. Single member LLCs are disregarded entities by the IRS and you should not pay yourself rent for the space. That is not a satisfying answer for a variety of reasons. First, there is inadequate case law for LLCs because of the newness of the form. These issues just haven’t been litigated enough to know exactly where to stand. To borrow general rule for “piercing the corporate veil,” courts will pierce the veil when the corporate form has been disregarded by its officers and directors. It is best to follow the few formalities required by an LLC.
Another problem with home offices is the commonality of ownership between the house and LLC. Home offices have become common place, and having the same phone number and address probably would not be enough to “pierce” the LLC. Combined with other issues such as commingled* bank accounts and property, it becomes more likely that a court will disregard the corporate form. The important thing to remember when operating any business entity is to treat your business as distinct from yourself.
*Never, ever, ever commingle your personal and business funds. Open separate accounts for personal and business uses and make sure you keep those accounts separate.
Interestingly, I spoke with an accountant who has been practicing for over 30 years the other day who recommended that a single-member LLC should “lease” its vehicle from its owner in order to protect itself from “veil” peircing. I suspect you are right, there is a lot of grey area around LLCs, and the advice of doing everything possible to keep one’s business activities and assets distinct from personal ones is critical.
First off regarding the leasing of vehicles - one thing you should be aware of is that the leasing of vehicles or any other equipment or personal property to an LLC, corporation, or any other entity is taxed by the IRS as non-passive income subject to self employment tax (unlike the rent of real property). In trying to protect assets from “veil” peircing, I often see taxpayers make the mistake of recording it as passive income. If you are going to rent personal property, at least lump it together with an office rental on one Schedule E form; however, even then you do run some risk if ever audited.
With a single-member LLC, you really do not need to rent a home office from a tax standpoint. The SMLLC is a disregarded entity and treated just like a sole proprietorship on a Schedule C, and like a sole proprietorship you would simply use the office in home deduction (Form 8829) for any home office space used exclusively for the business. As far the legal ramifications and “veil” peircing - I’ll leave that to the lawyers, but I do not think the use of the home office deduction would necessarily pierce the LLC or make the home office an “asset” of the SMLLC - espeically if you not taking any depreciation.
Grey areas abound with LLCs - especially with self-employment taxation of ordinary income from multi-member LLCs. There is little to no guidance and you have CPAs and owners taking position everywhere from no self-employment tax on the ordinary income to 100% SE taxability. It is crazy, but then again it is job security for me so I guess I shouldn’t complain.
I’ve found many CPA’s using the practice of having the owner’s of single or multi-member LLC’s paying rent to one of the members for the use of the home office, instead of taking the regular home-office deduction from form 8829. The main benefit I see here is that it basically reduces the self-employment tax imposed on the net income from the entity, and while the income from the rent is reported on the member’s personal tax return on a schedule E, it goes in most times as passive income, not subject to SE tax. This line of thinking and strategy seems like a very grey-way to reduce your SE tax when self-employed. What is your impression of this strategy?
@Victor
I’m assuming the analysis would be the same as if it where an LLC leasing space from the another company that has the same ownership. I’m not sure how this would work for renting a room from residential property though. I’m not a CPA or Tax attorney but I usually error on the side of caution on those types of things.
I also found this information published on Intuit’s site for TurboTax relating to home office deduction questions, but it also mentions the situation we’ve discussed above:
Corporations, Partnerships, and Multi-Member LLCs
Individual owners of S corporations, partnerships, and multi-member LLCs may also be able to take a deduction for home office expenses if they qualify.
Partnerships and Multi-Member LLCs
The partner (or LLC member) using the home office as the business’s only office can claim the deductions on the personal return (on Schedule E).
Alternatively, the partnership/LLC may pay rent to the partner for use of the home office. The income and expense would then be treated as a rental activity on Schedule E of Form 1040. If the partner is an active member of the partnership/LLC, the activity is considered non-passive.
It also went on to mention Sole Proprietors and Single-member LLC’s, but only mentioned the regular home office deduction in that case. It appears that if there are at least two members in the LLC, paying rent for the use of the home office by the partnership wouldn’t be as aggressive as doing it with only a single-member LLC.
This idea isnt half bad…. if you conducted your home office as if it were commerical rented place you might have enough aside for some nice upgrades!
love it