Escape The Home Office Trap By Electing Sub S Status
If you’re self-employed and work from your home, there’s a simple way to sidestep a potential tax trap involved in future home sales. All you have to do is adopt the S corporation form of doing business.
When you operate your business as an S corporation, the entity files an annual tax return on Form 1120S. Similar to a partnership, items of income and deduction are then passed through to the shareholders on Schedule K-1. Assuming you’re the sole shareholder, you claim 100% of the income and deductions on your personal return.
If your home office is your principal place of business or a place where you normally meet with clients, patients, or customers, you can still qualify for home office deductions. The deductible expenses relating to your home office (utilities, insurance, repairs, gardening, security services, etc.) are claimed on the S corporation’s return.
There’s no place for reporting home office expenses on you personal return when those deductions are passed through from the S corporation. You don’t have to file Form 8829 (Expenses for Business Use of Your Home, which is required for self-employed taxpayers taking a deduction for an office in their residence).
You won’t be trapped by the 2 out of 5 year requirement or the depreciation recapture rule when you sell the home. Your entire gain, up to $500,000 for joint filers, will be tax free.
There are other tax considerations involved when you set up an S corporation. S corporations can’t deduct employee fringe benefits provided to its owners and the owners are taxed on undistributed income. Also, forming an S corporation results in more paperwork.