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socrateaser
socrateaser, Attorney
Category: Business Law
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Experience:  Retired (mostly)
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I will be going into business renting/leasing out space to

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I will be going into business renting/leasing out space to store cars in a 4900 sf warehouse located on the back of my property. I understand that rentals/leasing of storage-units is considered passive and the deductions and accounting for that will go on my schedule e. However, I will be managing all activities from getting customers, driving individuals to specified locations after they drop off the cars, picking them up, periodically starting cars so batteries don't die, rotating tires, to other car needs for the customers, as well as maintaining and completing other necessary paperwork and meeting the customers in my home's office.
As I will be actively managing the business, I would like to know how I can report a portion of monies (deducted from the schedule e "management" fees) on a schedule c so I can take advantage of home office deductions which are not allowed for a schedule e? I have another full time job and will probably not meet the 750 hr need to be considered a real estate professional. Do I need to set up two separate business', one for the storage and one for the management of the properties, or is this considered one business and all of the profit/loss be attributed to either the schedule c/schedule e? And what type of business structure would be best for this venture...sole proprietorship with umbrella policy or llc? Thank you in advance.
Submitted: 1 year ago.
Category: Business Law
Expert:  socrateaser replied 1 year ago.
Hello,

The easiest way to handle this issue would be to not treat these leases as storage space, which is a passive real estate transaction -- and instead, operate your business as a "warehouse" under the Uniform Commercial Code Fl. Stat. Chapter 677. Operating your business in this manner would make it entirely a Schedule C activity, not subject to the real estate activity requirements.

Hope this helps.
Customer: replied 1 year ago.

After talking to an owner of a car storage facility, he was previously told that the leasing of his space still constitutes as rental and passive activity. He has a manager, so there is no need for him to have a schedule c. But what I would like to do is to be able to use managerial portion of my business for a schedule c thereby allowing home office deductions and Self Employment taxes for only the portion of Managerial Pay, while all the rest of the business(storage) is then put on my schedule e, and not subject to SE taxes.

Expert:  socrateaser replied 1 year ago.
Sorry for the delay, but I wanted to do some research.

In Sweet v. C.I.R., T.C. Summ.Op. 2004-125 (2004), the U.S. Tax Court indicated that former Int. Rev. Code Section 1372 was relevant in determining passive activity rules concerning rentals.

The IRS published Rev. Rul. 65-91, which interpreted IRC 1372. In the ruling, the IRS discussed the difference between a passive and active storage rental -- describing an activity which was not a passive rental activity as being one in which, "Separate fees are charged for receiving the grain and for taking the grain out of storage and loading it on carriers for shipment. While in storage, services must be performed to prevent spoilage and infestation of the grain. These services include periodic inspection and turning of the grain. If the grain were to be improperly handled during storage, the corporation would be liable without the possibility of insurance protection for the full value of the spoiled grain. ¶ Under these circumstances, it is held that fees received for the storage of grain are not rents within the meaning of section 1372(e)(5) of the Code because of the significant services performed in connection with the storage."

Obviously, vehicle storage is not grain storage. However, the similarities are equally obvious: if part of your storage activity is to "turnover" the vehicle engines, wash vehicles, you are taking responsibility for the vehicles (unlike a typical self-storage facility), and you are not renting a specific space, but rather only the right to store the vehicle in your facility, then you are effectively doing the same thing as found in the example of grain storage in Rev. Ruling 65-91.

Now, I don't know if you want to go through the exercise of actually conducting your business so as to materially participate and take responsibility for the stored vehicles. But, if your goal is to convert this activity entirely into a Schedule C business, then what I'm describing is the means by which to accomplish that goal.

If not, then your business is entirely a Schedule E activity, and depending on whether or not you can meet the 750 hour test-50% personal services test, you cannot deduct office expenses separately from your rental activities. However, if you meet the active participation test, then you can deduct up to $25,000 in passive losses against your ordinary income. Regardless, all expenses would be reported on Form 1040, Schedule E.

Hope this helps.
Customer: replied 1 year ago.

Thank you for your response. I guess what I am trying to do seems like it is not possible...having a portion of the business on the Schedule E, and the managerial with home deductions on the Schedule C. That is my ultimate goal...but having everything on the Schedule C will force me to pay Self Employment taxes unless I can structure the company in a way to only pay a portion as income and the rest as profits...maybe an llc as an s corp...any thoughts, because, although I may be performing services on the cars, they may not qualify as "significant" and the grain example would not apply.

Expert:  socrateaser replied 1 year ago.

I understand. Unfortunately, material participation which creates a business activity also creates liability for self-employment taxes. Passive activity avoids self-employment tax, but eliminates the home office deduction, because your rental activity is not a trade or business.

I have reviewed about 50 U.S. Tax Court cases. In each and every case, the court ruled against the taxpayer and disallowed the home office deduction, where the taxpayer was not able to satisfy the 750 hour/50% personal services test. Because of this survey, I believe that you will be stopped dead in your tracks attempting to use a home office deduction for the purpose of managing your storage business -- unless you can satisfy the 750 hour/50% personal services real estate professional test.

Hope this helps.

Expert:  socrateaser replied 1 year ago.
Hello again,

I have an idea that could work for you, but only if you intend to treat your business entirely as material participation, as previously described.

You could form an S Corporation, pay yourself a small salary, and then allow the remaining profits to pass through to you via a K-1. The K-1 profits are not subject to self-employment tax -- but, you will incur payroll taxes on your salary, which includes FICA, FUTA, Medicaid, and workers' compensation contributions. You would have to run the numbers and see where the breakeven is -- but, this would be the closest you could get to accomplishing your goal, in my opinion.

Hope this helps.
Customer: replied 1 year ago.

Your last response was one that I was first going to try and do by forming an llc and electing by an 8832 to tax it as an S Corp, even as a single member llc, as FL law allows you to do so. The only problem with that is the paperwork headache to accomplish all of what is necessary to keep it intact...but if that is the only way to do it, then I will have to go that route. The other problem with that regard is that you will still not use the home office, or that it will set off flags with the IRS as my business is mainly used as passive income.


In the end, I may just have to forego the Schedule C and 8829 for home deductions and just set it up as a passive entity. I still have a few months before I set this matter up, and will continue to see what other options I may find.

Expert:  socrateaser replied 1 year ago.

See this link concerning deducting the cost of using your home as part of an S Corporation.

Maybe I'm missing something important, however I don't see any benefit to forming an LLC first, and then electing S Corporation tax status. I would just form a corporation and then elect S Corp status.

Hope this helps.

Customer: replied 1 year ago.

I will look at this option, but I mainly stayed away because of the paperwork nightmare. And the reason I was looking at the LLC and taxing it as an S Corp was to truly benefit from the limited liability of having an LLC. I will do some more research on this subject and see whether or not it is truly worth the extra time and energy of putting all the paperwork together and whether I can benefit from all of my deductions as well as have the Limited liability I was looking for. An S Corp takes more time and costs more to set up, but I might have to go back to my original plan if I am unable to make the sole proprietorship or llc work.

Customer: replied 1 year ago.

I received an answer from a different expert who stated that the tax courts have allowed individuals from rental business' to add the home office deductions as a miscellaneous deductions and attach the 8829 to the Schedule E under "other:line 19". This would allow me to be a sole proprietorship and not have to deal with the hassle of setting up an S Corp. I would not be able to e file, as tax programs would not allow me to add the 8829, which is mainly supposed to be used for a Schedule C, but the fact that tax courts have allowed home office deductions in this manner would be worth it to me to file it manually...


 


Thoughts??


 


Thanks in Advance.


 


 


Expert:  socrateaser replied 1 year ago.

I reviewed the other contributor's Answer. Ask him to cite the U.S. Tax Court case that he asserts supports his position. I'm always up for learning something new -- but, until I've reviewed the opinion myself, I'm sticking with my Answer, because I haven't been able to find the case (or any case, for that matter) which would support the position that a person who is not a real estate professional can claim a home office deduction for rental real estate activities.

 

FYI: U.S. Tax Court opinions, while persuasive, are not binding on the IRS, unless a U.S. Federal Court has affirmed the Tax Court opinion, and the IRS has formally "acquiesced" to the court's opinion (except for a U.S. Supreme Court opinion, of course).

Hope this helps.

Customer: replied 1 year ago.

Here is the response received. I will still seek the advice of a tax professional but want to have a good basis of information and direction before I use that route:


 


"In Curphey v. Commissioner, 73 T.C. 766 (1980), the Tax Court permitted a home office deduction where the taxpayer owned several rental properties and managed them from his home office. The issue in Curphey was whether the taxpayer's rental activities rose to the level of a trade or business. The IRS conceded that the taxpayer was entitled to a home office deduction if the trade or business issue were resolved in the taxpayer's favor.


 


 


The Tax Court's opinion did not express its view with respect to the principal place of business question. However, the language added by the Taxpayer Relief Act of 1997 to Code Section 280A(c)(1) would clearly indicate that such a home office would qualify as the principal place of business as long as there were no other fixed location where the administrative or management activities were carried out.

Expert:  socrateaser replied 1 year ago.
Okay, thanks.

I don't believe that Curphey is good law. The issue in Curphey has not been revisited since IRC Sec. 469 was added (1986), concerning the passive activity rules for real estate professionals. It seems to me entirely inconsistent that Congress would have defined a trade or business for real estate professionals seeking material participation status as requiring 750 hours and 50% personal services during the year, while simultaneously permitting a non-real estate professional to take the home office deduction under IRC Sec. 280A, under the legal theory that the office is the taxpayer's "principle place of business."

A taxpayer who engages in passive real estate investment has no principal place of business, because the taxpayer is not engaged in business -- the taxpayer is engaged in an investment. Curphey's references to supporting U.S. Supreme Court opinions predate the inclusion of IRC Sec. 469.

That said, the U.S. Supreme Court also issued a ruling in Commissioner v. Soliman, 506 U.S. 168 (1993), in which the court created a two-part test to determine whether or not a home office meets the "principal place of business" requirement:

  • Where a taxpayer's business is conducted in part at a home office and in part at other locations, the following two primary factors are considered in determining whether the home office qualifies under sec. 280A(c)(1)(A) as the taxpayer's principal place of business: (1) The relative importance of the activities performed at each business location and (2) the amount of time spent at each location. Commissioner v. Soliman, 506 U.S. 168, 175-177 (1993).

 

There are two ways to look at the current legal landscape: Since the IRS has won substantially every single home-office-deduction-non-real-estate-professional case brought to the U.S. Tax Court since Curphey, perhaps the IRS doesn't believe it needs any additional ammo to prevail over anyone it deems is not clearly within the scope of the very complicated and highly discretionary rules created by Curphey and Soliman.

 

Or, maybe the IRS believes Curphey is good law, so it doesn't bother challenging any circumstance where it appears that a taxpayer appears to have managed to "thread the needle."

 

From where I'm sitting, you are about to engage in a business that's quite different from any of the previous cases. If you want to go with the Curphey decision as giving you license to deduct your home office as the place of business for your vehicle activities, that's your decision. But, the question may arise as to where most of this business is done -- in your office, or in your warehouse. And, the IRS could turn the entire table around on you and try to show that you are engaged in a non-rental-real estate business, and that this is all ordinary income, subject to self-employment tax.

 

All of this is way to dicey for me. I would just form an S Corp., pay myself a small salary, and then operate the business as a vehicle storage operation, not as rental real estate.

 

Choice is yours. I've done my best to explain the law. Best wishes.

socrateaser, Attorney
Category: Business Law
Satisfied Customers: 34682
Experience: Retired (mostly)
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Customer: replied 1 year ago.

Thank you for your information...I think an S Corp is the way to go if I want to deduct the home office expenses.

Expert:  socrateaser replied 1 year ago.

FYI: The comments from the other contributor concerning Curphey appear to be extracted verbatim from this webpage. I don't know anything about the author, other than that the website identifies him as a CPA.

Anyway, I did give some additional thought to the formation of an LLC and then electing corporation and then S Corporation tax status -- and I can now identify a good reason for doing so. An S Corporation requires articles of incorporation, board meetings, bylaws and formal resolutions to operate the business. An LLS, and in particular a single-member LLC does not require any formalities -- it doesn't even require an operating agreement, though it's probably a good idea to have one. But, since it's possible to "pierce the corporate veil" by showing that the formalities of corporate existence were not followed, it does seem that beginning with an LLC form may actually provide an additional layer of protection that I hadn't previously considered.

However, you still must keep your business and personal assets, liabilities, income and expenses separate, in order to avoid having corporate existence avoided by a court.

Anyway, that's it -- good luck with your business.



Customer: replied 1 year ago.

Thank you so much for your time and expertise. I have done quite a bit of research on this matter and I am glad you concur with my earlier assessment that I should set up an LLC and then electing S-Corp status instead of going the straight S-Corp route if I could not find a way to simplify it by not going the S-Corp route. I am still in the initial stages of trying to set up this venture and want to make sure that I have done everything correctly in the beginning so I dont have any problems in the future...again, thank you for your expert advise.

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