After Moving In
This chapter outlines issues you might face upon moving into a new property: specifically, record-keeping, inspection issues, and ways to deduct the cost of workspace from your taxes.
Whether you own or rent property, keeping accurate and thorough records is very important. These records are your insurance against lenders or creditors who claim you did not make a payment, or contractors and other professionals with whom you might have a dispute. Keep copies of the following records on your property, and the originals in a safe deposit box:
Records of your purchase and ownership of the property:
Receipts for any expenses on or before the closing
Copy of the Mortgage
Copy of the Mortgage Note
Copy of the Deed of Trust
Copy of the Truth-in-Lending Disclosure
Copy of the HUD-1 (if applicable)
Your warranties on the property
FHA- or VA-related documents (if applicable)
Copies of other vital records
Copy of hazard or property owner insurance policy
Mortgage, life or flood insurance policies
An inventory of your personal property, kept on the premises, and its value. Include any equipment and supplies used in the production of your artwork. Take photographs of everything
Documentation of your own artwork and its value. Many property insurance policies will not cover your artwork or in-home studio, so you might need to amend or supplement your existing policy to obtain that coverage. See Chapter 19: Insurance for information on insurance.
Maintenance, Repairs and Property Improvement Records:
Utility bills and receipts
Receipts for any repairs, including labor and materials
Warranties on any items that could be sold with the property, such as equipment and appliances
Descriptions of improvements you've made to the property, and documents and receipts showing the cost of the work. Take before-and-after pictures.
Tax and Mortgage Payment Records:
Receipts for all mortgage payments. A portion of your real estate taxes and mortgage interest payments are deductible from your federal income taxes.
Annual statements from the lender showing how much principal and interest you have paid.
Other receipts for local taxes or assessments you have paid.
Receipts for dues paid to Homeowners, Condominium or Co-operative Associations;
Other receipts, such as maintenance expenses
Copies of any contracts you have with contractors. In the event that a dispute arises, this will be your proof of the agreed-upon terms between both parties.
Your inspection report.
Store your original documents in a safe deposit box in order to maintain a back-up in the event your copies become damaged, lost or destroyed. Copies may be used for most transactions, i.e. refinancing a mortgage, or making a claim.
Even if you ordered a property inspection prior to occupying your new space, undetected issues such as a defective kitchen appliance, sticky door or window, peeling paint or leaky faucet could arise. More serious defects can be difficult to detect, including problems with structural integrity, plumbing, heating, cooling, electrical systems, or the roof and sewer.
Additional considerations for older properties and new construction:
For Older Properties
Without an extended property warranty, you are unprotected if defects to the property occur. Extended warranties usually provide coverage for major structural and design problems. These warranties can last up to 10 years, and are typically available for residential spaces. If you buy a newly renovated property, check for a warranty -- especially if you purchase the property through a federally-backed mortgage such as an FHA or VA loan. The warranty should cover major defects for at least one year after purchase. These are typically available for residential spaces. Many warranties don't cover pre-existing conditions, so read the fine print. Your warranty company might disallow your claims, based on information contained in inspection report.
For New Construction (you are the first property owner)
Obtain a warranty from the builder that the property is free of major defects, and that all systems will work properly. Note time limitations and other restraints. The builder might grant you a written warranty as part of your Purchase Agreement or under a Homeowner's Warranty Program sponsored by the National Association of Property Builders. Residential properties subsidized by HUD/FHA (U.S. Department of Housing) under Section 235 are warranted for a period of one year from the date of purchase. New homes and commercial properties are not defect-free. In fact, many inspectors find more problems with newer buildings than with older ones. With new buildings, the completion and workability standards are higher than with older properties; today's contractors are required to know more about installing construction and building materials than contractors did 80 years ago. Look for solid construction work that meets the Seattle Building Code and all manufacturers' and construction standards. This is critical.
Insist with any new construction that you have a warranty. In addition, ensure that your builder completes any construction problems discovered during your first year of occupancy. If you make these repairs yourself, or even pay other professionals to fix them, most builders will claim that you voided their warranty and will then refuse to reimburse you or make any additional repairs. Address these possible scenarios in the initial negotiations.
TIP: Save all your cancelled checks and money order stubs; they might be your only receipts for repair jobs.
TIP: Keep original documents in a safety deposit box, and copies on your premises. This allows you a back-up in the event of fire, flood or loss.
TIP: Should repairs be necessary, have an inspector review "before and after" situations in order to document the nature and security of the repair. S/he should be able to document who is responsible for the breakdown. This is not so critical for a faulty refrigerator, but may be crucial after a flood event.
Various options are available for deducting workspace expenses on your taxes; we discuss a few of them here. Seek the services of a qualified accountant or tax preparation specialist to assist you with your own workspace deductions. See Chapter 4: Professional Services for more information on hiring an accountant or other tax specialist.
Deducting the cost of space used for a business is one of the beneficial aspects of being self-employed. For purposes of this discussion, an individual's art practice is considered self-employment, not a hobby.
The deductions described below are viable for all artists, even those not making a living off their artwork. In addition, these deductions can be used whether an artist has an in-house studio/workspace or utilizes an off-site location.
The information presented in this section is geared primarily to individuals. Nonprofits and businesses should seek the services of an accountant or other tax specialist when preparing their taxes.
Key factors for taking "business use of the home" deductions on federal income taxes include:
The percentage of your space exclusively used for business purposes will determine the amount of rent/mortgage and utilities you can take as a tax deduction.
To take business use deductions from your home expenses, the space must be used regularly and exclusively for business only. If you do anything else in that space aside from conducting business, you will not be allowed to take the deduction. For example, if you use your bedroom as your office or art workspace, you cannot take the deduction.
The federal deduction you are allowed to take may affect your state and local taxes, depending upon the state's particular tax-reporting forms.
Explanations of federal tax forms you should know:
Form 1040 Used to report individual income tax returns.
Form 4562 Used to claim depreciation and/or amortization on your property, and to report information about the property. Depreciation is the amount the property declines in value each year. Amortization is the elimination of the mortgage debt through regular payments over a specific length of time.
Form 8829 Used to report expenses you incurred when using your residential space for business purposes.
Schedule A Used to take itemized deductions such as your mortgage interest, property taxes and other casualty losses. If your business is based in your home, the deductions you take here would not be related to the business use of the space, only the residential use. The deductions you would take for your in-house studio space would not be documented here.
1040 Schedule C Used to report self-employment income.
If possible, and depending on how complicated your tax returns are, seek the services of an accountant or other tax preparation specialist. You may think you cannot afford this service, but accounting fees are a tax-deductible business expense. Also, you may receive a larger refund, and will have less chance of an audit.
The remainder of this section discusses how to deduct from your federal income taxes the costs associated with maintaining a workspace, specifically in live/work or work-only arrangements.
Workspace in Your Living Space
Disclaimer: The following sections have information about income tax reporting and deductions, but this is intended by way of information and example and is not tax advice applicable to your specific circumstances.
If your business is located in a residence that you own, you are allowed to deduct a percentage of your mortgage interest and property taxes annually from your federal income taxes. If you lease, residential or commercial/industrial, you can deduct a portion of your monthly rental payments. In both cases - purchase and rental -- the deductible percentage is based on how much of the space is dedicated to the business.
If 15% of your overall space is dedicated solely to the business, then 15% of your mortgage interest and property taxes or rent can be deducted from your taxes. You would report this deduction on Form 8829 and on your 1040 Schedule C. So, if you paid $1,500 in mortgage interest over the year, but your business used only 15% of the space, then you can deduct $225 or $1,500 x 0.15 in expenses.
You are also allowed to deduct the mortgage interest and real estate taxes for the non-business portion (i.e. the living side) of your space. Take this deduction on Schedule A of Form 1040. This situation involves taking itemized deductions rather than the standard deduction, because you usually get a larger deduction.
Whether you rent or own, other expenses related to your business use of the home (i.e. heating, electricity, etc.) can only be deducted if the business that occupies the space makes a profit. Any business use of the home expenses not deducted from your taxes (because the business does not generate a profit) can be carried forward to years when the business does generate a net income. At this time, you would then be allowed to deduct any business use of the home expenses carried forward from previous years.
For example, in 2020 the business portion of your space expenses equaled $1,500. However, you did not sell any paintings that year, and your primary source of income came from an office job. The same scenario repeats itself the next year. In this situation, you are not allowed to take any deductions for the space either year, because your use of the space for business purposes did not yield a profit. So far, you have accumulated $3,000 in expenses that you cannot deduct.
However, two years later you start selling enough paintings that your art business generates a net income of $5,000 after all business expenses are paid. Finally, the $1,500 in space-related expenses you sustained for that year can be deducted from your taxes, as well as the accumulated $3,000 you could not deduct for the previous two years. When you combine the total deductions you are eligible to take, they are worth $4,500.
As mentioned previously, the amount of the deduction you can take for business costs is directly proportional to the percentage of space the business uses in the property. To calculate the percentage of space used for the business, divide the business square feet by the total square feet of the living space. Maintain thorough records of your art business, in case you need to justify your art proceeds or space use to the Internal Revenue Service.
Workspace Separate from Your Living Space
When your living space and workspace are separate, you can take a tax deduction for business expenses even if your business does not make a profit. This includes any rent you pay for storage, renting a studio or access to specialized space (i.e. you rent time to use the rehearsal space at a dance school, or use the dark room at an arts center). You can make these deductions regardless of whether you rent or own your workspace. See the previous section for more information about deducting workspace that is a part of your living space. In this situation, simply deduct the business portion of your expenses on Schedule C of Federal Form 1040.
For example, if you own a two flat, and work in one unit and live in the other -- or if you have a storefront property, run a business in the first floor space, and live in an upstairs residential unit -- you can deduct your business expenses. If you rent a workspace separate from your home (i.e. studio space, office space, etc.), the full amount of the business expense is deducted on Schedule C of Form 1040.
Tax laws require that any real estate property you own and use for business purposes must be depreciated. This is not an option. Depreciation is the deduction from your taxes of the cost of the property over a 39-year period.
For example, if you paid $50,000 for a building, you would be allowed to take an annual tax deduction of approximately $1,282 in depreciation over the next 39 years. The depreciation amount represents the building's price, divided by 39.
Depreciation is based only on the value of the building. When you purchase a property, your price includes both the cost of the building and the land. When you purchase a property that you will use for business purposes, know exactly how much of the cost is for the building, and how much is relegated to the land.
For example, if you paid $200,000 for a property, and 25% of this cost reflects the land value, the depreciation over 39 years would be $3846.15 per year. This figure is derived by first determining the percentage of the price that reflects the cost of the building - $200,000 x 0.75 = $150,000. Then, take this new figure -- which represents the cost of the building-only ($150,000) -- and depreciate it over 39 years, or $150,000/39 = $3846.15. In this example, you would be allowed to deduct $3,846.15 in depreciation from your taxes for the next 39 years.
If you are using only a portion of the building for business purposes, you will only be allowed to deduct a percentage of the depreciation. Again, the percentage you can deduct is directly affected by the amount of space dedicated solely to the business.
Using our previous example, if 30% of the space is for the business, you are only allowed to deduct 30% of the entire building's depreciation, or $1153.80 ($3846 x 0.30).
This deduction is reported on Schedule C of Federal Form 4562 or Form 8829.
When real estate used for your business is sold, and you make a profit, you will have to pay capital gains tax. This tax is paid only on the amount of money you earned, minus the costs you incurred while purchasing the property. These costs include the original purchase price, costs of improvements to the space, and expenses you acquired selling the property (real estate agent's commission, advertising, etc.). You will also have to pay a 25% tax on any depreciation you took as a deduction on your taxes in prior years.
Using our example from the previous section, the property that cost you $200,000 initially has increased in value within the last five years to $450,000 and you decide to sell. Because you have a profit of $250,000 ($450,000-200,000), you will have to pay Capital Gains Tax on that $250,000, as well as an additional 25% on the depreciation you deducted from your taxes. Over each of the five years you owned the property, you deducted depreciation in the amount of $1,153.80 each year, for a total of $5,769 in deductions. Now that you are selling, you will owe depreciation taxes in the amount of $1,442.25 ($5769 x 0.25).
If, however, the business or studio is located within your living unit, you might not have to pay capital gain taxes. As long as you meet all other qualifications required for sale of a personal residence, you are allowed to acquire up to $250,000 in tax-free profit from the sale of your home. Married couples filing jointly are allowed to earn up to $500,000 in tax-free profit.
To be eligible, you must own the property you are selling, and have used it as your primary residence for at least two of the last five years prior to the sale.
If your residential and business spaces are in separate units of the same building, the gain on the sale must be distributed equally between the two spaces. For example, if you have a two-flat and use one unit for business and one for living, and made a profit of $50,000 off the sale of the property, you must allocate $25,000 to the living portion of the property and $25,000 to the business portion.
Only the residential part of the property might be eligible for not paying capital gain taxes. However, by law you must pay income taxes on any depreciation you deducted after May 6, 1997, even if you have stopped using your home for business purposes.
TIP: To get an idea of the additional art-related tax deductions you might be able to take, review the worksheet section of David Turrentine and Associates' Website.
TIP: The IRS provides updated information for small business tax deductions each year in IRS Publication 334, Tax Guide for Small Business. Visit the IRS website to access a printable copy of the publication.