Taking Care of Business in the Home
Kevin J. Daum

This article was originally published a 2007 edition of Log Homes Illustrated magazine.

Next to owning your own home, the most desired part of the American dream would be to own your own business.   Some people see entrepreneurship as a means for creating a path to freedom financially and spiritually.  There is a strong attraction to calling your own shots and setting your own tasks without the boss looking over your shoulder scrutinizing your every move.  With proper financial planning and reasonable expectations, the entrepreneurial path can indeed be a rewarding experience.

Steve and Lisa Clark both worked in the corporate world for 30 years.  After trying retirement for a while they were growing bored and were in need of some excitement.  Steve had always dreamed of running his own business but didn’t quite know where to start.  They enjoyed the log home they built a few years ago and Lisa remembered that the log home company had talked to them about becoming a dealer.   

The Clarks met with Ben Johnson, the Vice President of Sales for Perfect Log Homes who had sold them their log home 4 years ago.  They discussed in great detail the opportunity to sell Perfect Log Homes in their county, which was currently an open sales territory.  After determining that Perfect Log Homes offered competitive commissions and provided strong marketing support, the Clarks decided that taking on a dealership might very well be the right path for them.

Steve and Lisa figured that the first, best place to set up their log home dealership was in their own home since it could serve as a model home as well as a place for working.  The Clarks had plenty of space in their 5-bedroom log home since the kids had all moved away so each of them chose a bedroom to call their own office.  Even though one bedroom was easily big enough to accommodate both of them, Lisa had already figured out that they each needed their own private workspace to maximize productivity and protect the sanctity and happiness of their 25-year marriage.

Lisa was a financial analyst in her previous work life so she focused on managing the finances while Steve’s experience in business development made him the perfect salesman.  Lisa did the smart thing and called Bruce their accountant for an appointment to find out what tax advantages could be had from having their own business in the home.

Bruce the CPA explained to Lisa that although being self–employed has great benefits from a tax standpoint they would need to be careful how they approached their reporting.  Most self-employed couples file their returns using Schedule C on their 1040 tax returns.  This offers individuals the chance to deduct many items paid for in the course of business.  Many business owners are aggressive about deducting items for marketing, entertainment, supplies, etc. However the Internal Revenue Service watches over Schedule C filings closely and audits a high percentage of self-employed tax returns.

Bruce and Lisa also discussed the idea of forming a corporation for the business.  This would make their business less subject to audit and could provide some liability protection if set up correctly.  Bruce advised Lisa this might be a good path once the business was successful since the fees and taxes associated with starting and maintaining a corporation can be overly expensive for a business making less than $150,000 annually.  Since that meant selling roughly $1,000,000 in log home packages a year, they agreed to revisit the discussion once the business was off the ground and running.

Lisa then excitedly asked Bruce about what is considered by many to be the holy grail of tax savings for small businesses, mainly the Home-Office Deduction.  Lisa was aware that the use of their bedrooms as offices entitled them to tax breaks and she and Steve wanted their fair share.  The ever-cautious Bruce brought Lisa back down to earth by explaining that the Home-Office deduction was not without its issues.

Bruce explained how the Home-Office deduction actually worked.  First one needs to establish what percentage of the home is being used for work.  In Lisa’s case they were using 2 bedrooms in a 5-bedroom house, which represents 40 percent of the home.  The other way to calculate would be to use square footage, which might result in a slightly lower percentage depending upon the size of the rooms and home.  Lisa and Bruce determined that based upon a somewhat exaggerated workweek of 7 days at 12 hours per day they would be using those bedrooms as offices 50 percent of the time.  Since a new business could very well require these hours to be successful they agreed to use this 50 percent to reduce the space percentage to 20 percent.

Now Lisa could deduct 20 percent of all housing expenses that weren’t currently being deducted.  The Clarks were already deducting their interest on their mortgage as well as their property taxes so neither of the big-ticket items was up for grabs in this calculation.  Eliminating these bigger costs left smaller expenses such as insurance, utilities and maintenance as the only deductions in this category.  Since their log home was fairly new the maintenance was minimal at less than $1,000 annually and their insurance was only $2,000 each year.  In fact it took every inch of brainpower for Lisa and Bruce to come up with $7,000 in legitimate expenses that could be used.  Since the Clarks could only deduct 20 percent of this amount their total deduction came to a paltry $1,400.

Lisa quickly realized that the real savings on the Home-Office deduction would be less than $500 each year turning her holy grail into a Dixie cup.  Additionally Bruce informed Lisa that in his experience claiming this deduction would significantly increase the likely hood of the IRS knocking on their door for an audit not too far in the distant future and his billable rates for audits would be far more than $500.

Although the conversation with Bruce had been as sobering as it was enlightening, Lisa and Steve pursued their dream like all good entrepreneurs.  They sat down to hammer out a business plan so they could both be in synch on how this business would be successful not to mention understanding when it wasn’t successful before it got out of control.  They calculated the monthly expenses necessary to run the business. They knew it would take several months before they might see any income and they needed to have enough money to cover the expenses in the meantime.

Steve knew that any successful business needs to invest in marketing and advertising in order to get the word out so he set out a strong plan which included log home magazine advertising, direct-mail, trade shows, a website and networking. He wanted to make sure they had enough money to market steadily for a year regardless of sales since consistent marketing was a learned formula for success.  Luckily Perfect Log Homes had a strong support program for marketing materials, tradeshows and some matching funds for advertising.  Steve felt he could make a strong impression on the community for around $20,000

Lisa meanwhile calculated all of their expenses for equipment, supplies, insurance, accounting and legal.  They also had to figure in phone costs and the possibility they might need outside help if things got busy.  Ultimately they decided that if they were going to get this business started with the highest chance of success they should be willing to invest roughly $35,000 not to mention their time and effort.

The Clarks sat down to figure out where this money would come from.  They figured they had three choices on how to cover these costs.  They could spend it monthly as needed from their income, they could take the money from their savings or they could borrow the money from a bank.

Although the Clarks were making plenty of money on a monthly basis from retirement and social security, their monthly income was not enough after taxes to fund the additional monies necessary for the business start-up.  They needed to look at the other two options.  Most of their savings was wrapped up in IRAs and 401K.  Since their investments were making good money and they weren’t anxious to liquidate them and make them subject to taxation they decided using their savings was not the best route for their needs.

By process of elimination they figured borrowing money from a bank would be their best approach.  Lisa talked to their local banker about business loans.  The banker informed them that there were limited loan programs available for start-up businesses where the owners had little or no experience in the field.  Most banks focus on large established companies who will borrow over $1,000,000.  He explained that micro business loans were risky and time consuming for the bank so they tried not to make too many of them.

Frustrated, Lisa called Bruce the CPA to see if he had any ideas.  Bruce connected Lisa with Marla, a local Mortgage Broker with whom he had done business previously.  Marla came out and met with Steve and Lisa.  After reviewing their financials, Marla suggested they take out a Home Equity Line of Credit or HELOC.  Marla explained to the Clarks that the HELOC would be easy to obtain due to their good credit, strong reserves and solid income.  Taking a HELOC would allow them to pull cash as needed without affecting the low interest first mortgage currently in place on their home.  Marla also checked with Bruce and determined that the Clarks situation allowed for the interest on the HELOC to be tax deductible making it a very reasonable way to go indeed.

In less than 30 days the Clarks had their HELOC, had finished their business plan and began their marketing program.  Together with the help of experienced partners and advisors they were able to embark safely and securely on the journey of owning their own home business.  Now all Steve had to do was sell, sell, sell and help new log home buyers obtain their dreams.

About the Author...
Kevin Daum is the Founder and CEO of Stratford Financial Services, a Real Estate finance and education company, founded in 1989. Stratford specializes in Purchase loans, Refinance loans and Custom Home Construction finance and has successfully financed thousands of clients. He is the author of "Building Your Own Home for Dummies" (Wiley), as well as "What the Banks Won’t Tell You." Mr. Daum was an Underwriter for Plaza Savings and Loan and Key Bank of New York. He is an INC 500 CEO and has been listed as one the 40 Most Influential People Under 40 in the San Francisco Bay Area. He is the Global Chair for the Edison Innovation Program with the Young Entrepreneurs' Organization (YEO) and is a founding Board member of the Bay Area Chapter of YEO.

Mr. Daum is a frequent contributor to numerous business publications on the subjects of Real Estate and Small Business leadership and speaks regularly on both subjects. He can be contacted at kevin@stratfordfinancial.com.