Imagine this: your Schedule C business buys a home at the beach, uses it solely as an entertainment facility for business, pays off the mortgage, and deducts all the expenses.
Now say, 10 years later, without any tax consequence to you, you start using the beach home as your own.
Is this possible? Yes. Are there some rules on this? Yes. Are the rules difficult? No.
Okay, so could you achieve the same result if you operate your business as a corporation? Yes, but the corporation needs to rent the property from you or reimburse you for the facility costs, including mortgage interest and depreciation—because you want the title to always be in your name, not the corporation’s name.
Basic Rules
The beach home, ski cabin, or another entertainment facility must be primarily for the benefit of employees other than those who are officers, shareholders, or other owners of a 10 percent or greater interest in the business, or other highly compensated employees.
In this situation, you create
- 100 percent entertainment facility tax deductions for the employer (you or, if incorporated, your corporation), and
- tax-free use by the employees.
Avoid Corporate Ownership
Should the corporation own the entertainment facility? No. You get the big benefits when you own the entertainment facility personally. How can you benefit from this approach, then, if your business is incorporated?
Two choices:
Own the entertainment facility personally, and rent it to your corporation. Such a rental arrangement triggers the self-rental rules. Make sure those rules are no problem for you by following the guidance in Self-Rental Trap-Avoid It Like The Plague!
Have the corporation reimburse you for the facility as a reimbursed tax-free employee business expense. A corporation can reimburse an employee for all expenses allowable under sections 161 to 199 of the tax code—which includes mortgage interest and depreciation.
Here’s what happens when your corporation properly reimburses you for the expenses:
- You, as the employee, do not have taxable income.
- The corporation gets the full deduction the law allows for the expenses.
- If the corporation is an S corporation, then those expenses reduce the corporate income and the corporation passes that reduced income to you—say, as the sole shareholder of your S corporation.
- You treat the beach home as if you deducted depreciation personally and recognize gain or loss on the sale using the beach home’s adjusted basis.
Proof of Use
You need to prove who uses the facility and when.
The simple way to do this is with a guest book. Require every guest to sign the book, and also have a column for the hours or days of use by the guest, depending on the type of facility (e.g., hours for a swimming pool, days for a beach home).
Takeaways
The employee facility deduction is straightforward. It has three splendid benefits for the small-business owner:
- You deduct the facility as a business asset.
- Your employees get to use the facility tax-free.
- You own the property and can use it personally without tax consequences once you no longer need it for business use. (Note that when you sell, you will have a gain or loss on the sale and some possible recapture of depreciation.)
If you think the entertainment facility could work for you, please give me a call on my direct line at 509-543-7600 or send a request HERE, and I’ll help you put this facility in place.
April 2022
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