Can Home-Office Tax Deductions Include Garage Space?Tax Planning
Do you claim a tax deduction for a home office?
Should you include or exclude your garage space in your calculations of business-use percentage?
Home-office tax deductions require a look at the garage and other usable space as possible positive or negative factors in the home-office calculation.
This takes more than a sentence or two. You need to read this article, because there’s more to the garage space questions and answers than meets the eye.
Besides the garage, this article also touches on the unfinished basement and attic. Do you have to count such\ spaces when figuring your business-use-of-home percentage?
Ronald Culp earned an office deduction for 78 percent of his home. That’s a nice percentage, but what’s really interesting is how the court looked at Mr. Culp’s home in deciding that 78 percent business use.
Mr. Culp ran a business printing legal documents from his home, where he exclusively used the garage, the finished basement, two and a half of the six rooms on the first floor, and the attic.
The IRS said that Mr. Culp could not include either the garage or the attic in his calculations because these were not usable spaces. Had the IRS won this position, Mr. Culp’s home office would have represented 64 percent of the home.
Unlike the IRS, Mr. Culp included both the attic and the garage in his square-footage computations to arrive at his claimed 94 percent business use of his home.
The court did not like either computation and made its own. Here’s how the court made the computation that produced the 78 percent business use of Mr. Culp’s home:
- The court counted the garage as office space because it could find no basis in law or fact for excluding it. (The garage held two printing presses and a large paper cutter that were integral to Mr. Culp’s business.)
- Regarding the utility room in the basement where the water heater and furnace were located, the court said this space failed the exclusive business-use standard for the home-office deduction and that such space counted as personal space.
- The attic, which measured 1,128 square feet, contained only 100 square feet of usable space. The court ruled that the other 1,028 square feet were not functional, because that footage was not accessible due to the slope of the roofline and/or the lack of flooring.
Observation. The printing took place in the garage, but the IRS said that such space was not usable space, and the IRS did not want it counted in the calculations. The taxpayer and the court agreed that the space should be counted in the calculations. Will this be true for the other garages in this article?
Garage Not Counted
According to the court’s description, Gene Moretti rented a 5.5-room house consisting of two bedrooms, a den, a living room, a dining room, and a half-kitchen.2 The court noted that “the house also had a garage” and that Mr. Moretti claimed business use of the den, living room, dining room, and garage.
The court concluded that only the den met the regular and exclusive use requirements for qualification as an office in the home.
To calculate the business percentage, the court used the number-of-rooms method and calculated that one room (the den) of the 5.5 rooms represented the business-use percentage of this home. The court ignored the garage even though Mr. Moretti tried to claim it as office space.
IRS Publication 587 on the home-office deduction contains this example:
- You use one room in your home for business.
- Your home has 10 rooms, all about equal size.
- Your office is 10 percent (1 divided by 10) of the total area of your home.
- Your business percentage is 10 percent.
IRS regulations contain the following:
If the rooms in the dwelling unit are of approximately equal size, the taxpayer may ordinarily allocate the general expenses for the unit according to the number of rooms used for the business purpose. The taxpayer may also allocate general expenses according to the percentage of the total floor space in the unit that is used for the business purpose.
Observation. Note that neither the IRS publication nor the IRS regulation mentions the garage.
Garage Considered Less Than a Room
Brian and Marcie Mallin won a victory when the summary court considered their workshop less than a room.
The workshop was built as an addition to the existing attached two-car garage, with a wall separating it from the garage and with its own overhead garage door.
This case occurred before the IRS issued its Revenue Procedure declaring that a business space within the walls of the residence could escape taxation under the $250,000/$500,000 home-sale exclusion rules.
The issue in this case is how much of the sales proceeds from the sale of the home should be allocated to Mr. Mallin’s business workshop.
The IRS used the square-footage method to measure the workshop as a percentage of the house and said that 9 percent, or $18,279, of the sales proceeds should be allocated to the workshop.
Mr. and Mrs. Mallin used $4,000 from an appraisal.
The court refused to use the IRS allocation because it believed “workshop space is not as valuable as living space in a home.” Instead, the court used two appraisals to arrive at a sales proceeds allocation of $6,500 (36 percent of the IRS amount).
Detached Garage Triggers Different Rules
Tax law states that the term “dwelling unit” includes a house, apartment, condominium, mobile home, boat, or similar property and all structures or other property appurtenant to such dwelling unit.6 Thus, the IRS in its proposed regulations considers the detached garage part of the home because the garage is appurtenant to the home.
Does tax law treat the detached garage differently from the attached garage? Yes! The following two rules apply to the detached garage and not to the attached garage:
- To deduct an office in a detached garage, you do not have to meet the tough tests for a principal place of business or the alternative test for a place to physically see clients, patients, or customers. Instead, the test to claim an office in the detached garage is simply that you use the office in the normal course of business. (Beware: To eliminate commuting, which is the prime purpose for many home offices, you need the home office to be your principal place of business. With correct use, the detached garage can qualify as your principal place of business, just as a bedroom or an attached garage can qualify.)
- Unlike for the office inside the walls of your dwelling unit, where the $250,000/$500,000 exclusions are available to offset gain on sale of the home office, the business use of the detached garage requires a separate calculation of gain based on the allocation of proceeds from the sale. In other words, the office inside the walls of the home can escape taxes on the gain, using the home-sale exclusions, but the office in the detached garage has no such escape.
Charles Scott owned a property that contained an office building 12 feet behind the house. The office building consisted of four rooms and a bathroom but contained no sleeping or kitchen facilities.
Because the office building did not contain sleeping or cooking facilities, it was not a dwelling separately subject to the home-office rules, but more like a detached garage. We don’t know how Mr. Scott made the computation, but the IRS agreed that the detached office building represented 25 percent of the property.
Joseph Morcos owned a property that had, in addition to a main house, a carriage house with a living room, kitchen, laundry room, bedroom, and bathroom. The carriage house met the tax-law definition of a dwelling; therefore, it was not appurtenant to the main house.
Thus, the carriage house and the main house stood alone with respect to home-office rules and calculations.
Deducting a Business Loss on the Sale of a Business Garage (When You Sell Your Home)
Regardless of the location of the attached or detached garage, any loss on sale of the business-garage part of the home is deductible.
The allocation of the sales proceeds from the home should be based on the same percentages that you use for the business-use percentage.
Example. Your percentage business use of your home is 12 percent. You sell your home for $325,000 and allocate $39,000 (12 percent) to the business part. The business part of your home has an adjusted basis of $54,000. You have a deductible loss of $25,000 on the sale of the business part of your home ($39,000 net sales proceeds minus $54,000 adjusted basis).
The 88 percent personal part of the sale is subject to the personal-residence rules.
Observation. On the office inside the dwelling itself, you get the best of both worlds:
- If you have a gain on sale, you pay no tax on the business part of the gain to the extent of the $250,000/$500,000 exclusion.
- If you have a loss on the sale of the home, you have a tax deduction for the business part of the loss.
The Two-Garage Case
In an effort to save time, the court tried two separate day-care cases together. Each case involved the use of a garage.
In both of these court cases, the IRS excluded the garages from its computations.
The court took an opposite view. First, it included both garages in the business-use-of-home calculations. Although it found that one garage met the requirements for the home-office deduction and one garage did not, the key point
is that both garages were in the calculations.
When you claim a deduction for an office in the home that includes business use of your garage, there’s no question that the garage space is part of the calculation.
There is no rule that says you have to give your garage space less weight than other space. Thus, if the garage is part of your calculation, your position is best served by counting the garage in full.
If you are using the number-of-rooms method and want to include the garage in your computations, the size of the garage might dictate two rooms or some other number. The half-kitchen in Moretti gives you a basis for why that should work.
If the garage is not part of your calculation, you might take the IRS position from Culp that the garage is not usable office space and thus should not count. The attic with the missing floor was not usable space. The garage with no heat and only a concrete floor should produce a similar result.
What is interesting in these court cases is that the IRS often excluded the garages, whereas the courts were eager to include them. Since you start any disagreement over your tax return with the IRS, this should work to your advantage.
You might think that the rules are a little unclear in this area. That’s true.
The science involved in tax law is finding cases, rulings, procedures, and publications that support your position. The art form is putting your spin on the deduction. That’s all you can do when neither the law nor the regulations give clear advice.