Two Homes, One Mortgage, Home Office Question

[annie21]

I have two homes. They are both on one lot and have one mortgage, but two separate addresses. They also have different cable and gas/electric, but same water line. They cannot be sold separately. (Old property laws.) For many years I used the second home as a rental unit with a tenant in which I filed normally on a Schedule E.

I gave my tenant notice and converted this home to 100% for my small business as of 8/1/21. My front house (that I live in) is 1000 sq ft., and the back house (which is my business), is 400 sq ft. This is not a new business but I did not use a home office deduction in the past even though I itemized normal things on my Schedule C. I just didn't have a designated home office in my main residence prior to 8/1/21.

So my confusion is about the Home Office Deduction. Someone told me (to simplify) that I should just combine the two homes (square footage-wise for tax purposes) for a total of 1400 sq ft. and just deduct the back house at 400 sq ft. , which is about 28.5% of the total square footage. So do I use that 28.5% for all my usual deductions? Or am I completely off base here? I know that I can deduct the office furniture, internet, etc. at 100% but am confused when I get to my mortgage interest, etc. Not sure if I am supposed to separate those for my overall deductions.

Thanks in advance.

[Critter-3]

Since this second home has separate meters/bills for all the utilities just enter them as direct Sch C expenses  and  use the same information you used for the Sch E on the Office in Home form 8829.  Any common expenses should be prorated between the 8829 and the Sch A. 

On the Sch E you will take the asset out of service (hopefully you have been depreciating it correctly ... if not RUN to a local tax pro to get this corrected properly)  then the asset is added to the office in home using the current adjusted basis.  If this sounds complicated then either find a local tax pro OR  upgrade to one of the LIVE options for personalize assistance. 

[annie21]

Thank you. That makes total sense and I understand. I appreciate you taking the time to explain. 🙂  And yes, I have been depreciating the rental home. 

[Carl]

I should just combine the two homes (square footage-wise for tax purposes) for a total of 1400 sq ft. and just deduct the back house at 400 sq ft. , which is about 28.5% of the total square footage. So do I use that 28.5% for all my usual deductions?

I would use the percentage of the total square footage only for figuring percentage of property taxes, mortgage interest and property insurance you can deduct, since those items are not billed separately.

Since the utilities are metered separately, assuming you receive two physically separate bills for each structure, then I'd claim actual utility expenses on the business use structure. If possible, I'd changing the billing name for the utilities on the business use structure, to the business name. Helps substantiate things "in writing" a bit better, in case you're ever questioned. But I really don't see you ever being questioned on it, unless you happened to be one of rare (and I mean extremely rare) "random draws" for an audit.

A heads up here, to check your property insurance policy. Typically a homeowner's policy insures the structure for "ordinary family/living use", and not for business use. So you may need to purchase a separate business insurance policy for the business use structure. Check your policy and check with your agent to "CONFIRM IN WRITING" that you are covered should anything happen in the business use property.

[annie21]

Thank you! I did get seperate insurance for business on the back house That is separate from my homeowners.