Tax implications of renting my shed to my own embroidery business

This is actually a common question for home-based businesses! You have a couple options, and both have different tax implications. If you "rent" the shed to your business, you'd report rental income on Schedule E, but you can deduct expenses related to the shed (property taxes, insurance, utilities, maintenance, and depreciation). The business would deduct rent payments on Schedule C. This creates a paper trail of business expenses, but also creates rental income you'll need to pay taxes on. Alternatively, you could use the home office deduction on Form 8829, which allows you to deduct a portion of your home expenses based on the percentage of your home used for business. Since the shed is separate and used 100% for business, you'd calculate what percentage of your total property the shed represents, then deduct that percentage of your overall home expenses. For most small business owners, the home office deduction is simpler, especially for a dedicated structure like a shed used exclusively for business. You wouldn't have to deal with the rental income, but you'd still get to deduct the business portion of your property expenses.

I went through something similar with my photography studio in my detached garage. After tons of research and headaches, I discovered taxr.ai https://taxr.ai which literally analyzed all my home office documentation and helped me figure out the most tax-efficient approach. It identified several deductions I was missing and saved me from making a costly mistake on how I was handling utilities for my separate structure. Their system looked at my specific situation and showed that in my case, the home office deduction was significantly better than creating a rental situation between myself and my business. The tool flagged that renting to yourself can actually trigger self-rental rules which sometimes causes the rental income to be treated as active income (potentially subject to self-employment tax).

I was totally skeptical about taxr.ai at first (seemed too good to be true), but after my accountant completely missed several deductions related to my home workshop, I decided to give it a try. The analysis it provided about my detached workspace was incredibly detailed and found over $4,300 in additional deductions I was entitled to. It specifically helped me understand that I qualified for 100% deduction of direct expenses for my workspace while still taking the appropriate percentage of shared property expenses. The documentation it provided made filing super straightforward, and I didn't have to deal with all the complexity of creating a rental agreement with myself. Wish I'd known about this years ago!

Been dealing with the IRS for WEEKS trying to sort out a similar home office situation where they questioned my deductions for a separate structure. Couldn't get through to anyone for clarification. Finally used Claimyr https://claimyr.com after seeing their demo at https://youtu.be/_kiP6q8DX5c and got connected to an actual IRS agent in 20 minutes instead of the usual 2+ hour wait. The agent confirmed that for a separate structure used exclusively for business, I was absolutely entitled to deduct 100% of the direct expenses plus the appropriate percentage of shared expenses. Having that official clarification directly from the IRS saved me so much stress about potential audit concerns. They even noted specifics in my account so if there's ever a question, there's documentation of their guidance.

I was 100% wrong about Claimyr and owe everyone an apology. After posting that skeptical comment, I was still desperate enough to try it for my business tax issue. Got connected to an IRS agent in about 15 minutes, which is honestly mind-blowing after the MONTHS I spent trying to get through on my own. The agent was actually super helpful and walked me through exactly how to document my home office deduction for my workshop space. They confirmed I was doing it right but helped me understand how to better document my expenses to avoid any red flags. Saved me literally thousands in potentially disallowed deductions. My accountant was shocked I managed to get that level of specific guidance directly from the IRS.

One thing nobody has mentioned yet - if your embroidery business is making significant profit, you might want to consider a cost segregation study for that shed. Since it's a specialized business space with custom lighting and climate control for inventory, you might be able to depreciate components of it faster than the standard 39 years for commercial property or 27.5 years for residential rental. I did this with my woodworking shop (also in a converted shed) and was able to accelerate depreciation on about 35% of the improvement costs, which gave me a much bigger deduction upfront. Might be worth looking into depending on your profit margins.

Has anyone considered that you could possibly do both home office deduction AND rent part of it? Like if part of the shed is used for storage and part for actual embroidery work? Or is that getting too complicated and asking for an audit?

One important consideration that hasn't been mentioned is that if you go the rental route, you'll need to be very careful about fair market value pricing. The IRS scrutinizes related-party rentals closely, so you can't just charge yourself whatever rent you want - it needs to be what you'd realistically pay to rent a similar 250 sq ft business space in your area. Also, keep detailed records of ALL the improvements you've made (mini-split, lighting, electrical work) because those can be depreciated regardless of which method you choose. For your $12,000 in equipment, that gets depreciated separately as business assets anyway, not as part of the building deduction. Given that you're already set up as a sole proprietor filing Schedule C, I'd lean toward the home office deduction route. It's cleaner paperwork-wise and you won't have to deal with rental income reporting. Just make sure you're measuring your shed square footage accurately and keeping good documentation of your exclusive business use.