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JBloggs

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If anyone feels like it, can they in a nutshell explain the whole depreciation thing for a B&B... I still do not have my head around this.
"You recover the cost of income producing property through yearly tax deductions. You do this by depreciating the property; that is, by deducting some of the cost each year on your tax return.
Three basic factors determine how much depreciation you can deduct: (1) your basis in the property, (2) the recovery period for the property, and (3) the depreciation method used. You cannot simply deduct your mortgage or principal payments, or the cost of furniture, fixtures and equipment, as an expense.
You can deduct depreciation only on the part of your property used for rental purposes. Depreciation reduces your basis for figuring gain or loss on a later sale or exchange."
More on it here
http://www.irs.gov/publications/p527/ch02.html
 

Madeleine

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It's stuff like this that keeps CPA's busy!
Ours basically looks at everything we've purchased for the inn for the year and tells us what's best. I think a lot of it depends on the life of the item as well. Something big and long-lived, can be spread out over a certain time frame. I think the time frame depends on the life of the item. Something with a shorter life span can be taken all at once. ie- depreciated the full amount in one year.
 

muirford

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It's stuff like this that keeps CPA's busy!
Ours basically looks at everything we've purchased for the inn for the year and tells us what's best. I think a lot of it depends on the life of the item as well. Something big and long-lived, can be spread out over a certain time frame. I think the time frame depends on the life of the item. Something with a shorter life span can be taken all at once. ie- depreciated the full amount in one year..
Madeleine said:
I think the time frame depends on the life of the item. Something with a shorter life span can be taken all at once. ie- depreciated the full amount in one year.
There were some special depreciation rules over the last few years - items that were 'accelerated', often computers and electronics. I'll have to look at the rules again for 2012 since we've purchased a bed in its entirety - that will need to be depreciated.
I still don't understand how the recapturing works and am not looking forward to having to figure that out.
 

gillumhouse

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The part the worries me is the gotcha of having to pay back any depreciation when I sell.........
 

JBloggs

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It's all a boondoggle!
I work for free as it is, and this is just chapping my hide.
 

Madeleine

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The part the worries me is the gotcha of having to pay back any depreciation when I sell..........
gillumhouse said:
The part the worries me is the gotcha of having to pay back any depreciation when I sell.........
This is why we all want to die with our boots on...
 

JBloggs

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The part the worries me is the gotcha of having to pay back any depreciation when I sell..........
gillumhouse said:
The part the worries me is the gotcha of having to pay back any depreciation when I sell.........
This is why we all want to die with our boots on...
.
Madeleine said:
gillumhouse said:
The part the worries me is the gotcha of having to pay back any depreciation when I sell.........
This is why we all want to die with our boots on...
So much for our idea of this as an "investment"
BTW our tax man said he can mention we are for sale as they have entrepreneurs going in there quite often. For those looking to sell, this might be another angle locally.
 

gillumhouse

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The part the worries me is the gotcha of having to pay back any depreciation when I sell..........
They will have to carry us out in a box!

.
Silverspoon said:
They will have to carry us out in a box!
I used to say that until I realized that my city NEEDS a B & B. If I give it up via the "feet first" route I had planned, I will have no say in the matter as to it staying a B & B or going back to being a residence. The only way I can control it - at least try to - is for me to sell it. So, if i outlive DH, that is what I will do.
 

BruceGreig

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It's stuff like this that keeps CPA's busy!
Ours basically looks at everything we've purchased for the inn for the year and tells us what's best. I think a lot of it depends on the life of the item as well. Something big and long-lived, can be spread out over a certain time frame. I think the time frame depends on the life of the item. Something with a shorter life span can be taken all at once. ie- depreciated the full amount in one year..
Madeleine said:
I think the time frame depends on the life of the item. Something with a shorter life span can be taken all at once. ie- depreciated the full amount in one year.
There were some special depreciation rules over the last few years - items that were 'accelerated', often computers and electronics. I'll have to look at the rules again for 2012 since we've purchased a bed in its entirety - that will need to be depreciated.
I still don't understand how the recapturing works and am not looking forward to having to figure that out.
.
I'm not an accountant, but I'm curious about this kind of thing, so I read up on it. Here's my understanding of how recapturing works, and why it happens.
It's easier to understand recapturing if you compare a house to, say, a tractor.

Let's say you bought a tractor for your business for $100,000. It lasts twenty years, after which it is worth $0 (to keep the numbers simple).

If you don't depreciate it a little each year, then when you finally dispose of it, you'd make a loss of $100,000 in that year. (It was worth $100,000 in your books. You sold it for $0. So that's a loss of $100k.) That's a bit crazy, so what you do instead is you depreciate one-twentieth of it every year, and take a little hit to your profits each year.

So by year 20, when you finally get rid of it, it is worth $0 on your books and you get $0 for it. So no massive loss in one year, you've spread it all over 20 years. Which makes sense - you've used it over 20 years, so the cost of it should be spread over 20 years.

But buildings are different to tractors. Buildings keep their value, or go up in value, over 20 years.

Even though buildings don't generally depreciate (in the sense of steadily dropping in value over time), the IRS still allows you to claim depreciation each year, just like with a tractor.

Let's say you buy a building for $1,000,000. You depreciate it by some approved amount every year. So after 20 years, your building is showing on your books as worth (say) $500,000.

Then you sell it for $2,000,000.

You just made a profit of $1.5m ($2m-$0.5m), which is taxable. That's the recapturing bit: the gain you record for tax purposes is the selling price less the book value (now artificially low, because of depreciation). (It's a bit more complicated than that, but that is the crux of it)

It seems unfair, but it isn't really - you've reduced you tax bill every year for the past 20 years thanks to the depreciation you took each year. Each year that's reduced your taxable profits a little, and hence reduced your tax bill.

Happy to be corrected if I've got this wrong, but that's my best crack at understanding and explaining it.
 

Mtatoc

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It's stuff like this that keeps CPA's busy!
Ours basically looks at everything we've purchased for the inn for the year and tells us what's best. I think a lot of it depends on the life of the item as well. Something big and long-lived, can be spread out over a certain time frame. I think the time frame depends on the life of the item. Something with a shorter life span can be taken all at once. ie- depreciated the full amount in one year..
Madeleine said:
I think the time frame depends on the life of the item. Something with a shorter life span can be taken all at once. ie- depreciated the full amount in one year.
There were some special depreciation rules over the last few years - items that were 'accelerated', often computers and electronics. I'll have to look at the rules again for 2012 since we've purchased a bed in its entirety - that will need to be depreciated.
I still don't understand how the recapturing works and am not looking forward to having to figure that out.
.
I'm not an accountant, but I'm curious about this kind of thing, so I read up on it. Here's my understanding of how recapturing works, and why it happens.
It's easier to understand recapturing if you compare a house to, say, a tractor.

Let's say you bought a tractor for your business for $100,000. It lasts twenty years, after which it is worth $0 (to keep the numbers simple).

If you don't depreciate it a little each year, then when you finally dispose of it, you'd make a loss of $100,000 in that year. (It was worth $100,000 in your books. You sold it for $0. So that's a loss of $100k.) That's a bit crazy, so what you do instead is you depreciate one-twentieth of it every year, and take a little hit to your profits each year.

So by year 20, when you finally get rid of it, it is worth $0 on your books and you get $0 for it. So no massive loss in one year, you've spread it all over 20 years. Which makes sense - you've used it over 20 years, so the cost of it should be spread over 20 years.

But buildings are different to tractors. Buildings keep their value, or go up in value, over 20 years.

Even though buildings don't generally depreciate (in the sense of steadily dropping in value over time), the IRS still allows you to claim depreciation each year, just like with a tractor.

Let's say you buy a building for $1,000,000. You depreciate it by some approved amount every year. So after 20 years, your building is showing on your books as worth (say) $500,000.

Then you sell it for $2,000,000.

You just made a profit of $1.5m ($2m-$0.5m), which is taxable. That's the recapturing bit: the gain you record for tax purposes is the selling price less the book value (now artificially low, because of depreciation). (It's a bit more complicated than that, but that is the crux of it)

It seems unfair, but it isn't really - you've reduced you tax bill every year for the past 20 years thanks to the depreciation you took each year. Each year that's reduced your taxable profits a little, and hence reduced your tax bill.

Happy to be corrected if I've got this wrong, but that's my best crack at understanding and explaining it.
.
I actually enjoyed reading that. Thanks!
 

Innkeep

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It's stuff like this that keeps CPA's busy!
Ours basically looks at everything we've purchased for the inn for the year and tells us what's best. I think a lot of it depends on the life of the item as well. Something big and long-lived, can be spread out over a certain time frame. I think the time frame depends on the life of the item. Something with a shorter life span can be taken all at once. ie- depreciated the full amount in one year..
Madeleine said:
I think the time frame depends on the life of the item. Something with a shorter life span can be taken all at once. ie- depreciated the full amount in one year.
There were some special depreciation rules over the last few years - items that were 'accelerated', often computers and electronics. I'll have to look at the rules again for 2012 since we've purchased a bed in its entirety - that will need to be depreciated.
I still don't understand how the recapturing works and am not looking forward to having to figure that out.
.
I'm not an accountant, but I'm curious about this kind of thing, so I read up on it. Here's my understanding of how recapturing works, and why it happens.
It's easier to understand recapturing if you compare a house to, say, a tractor.

Let's say you bought a tractor for your business for $100,000. It lasts twenty years, after which it is worth $0 (to keep the numbers simple).

If you don't depreciate it a little each year, then when you finally dispose of it, you'd make a loss of $100,000 in that year. (It was worth $100,000 in your books. You sold it for $0. So that's a loss of $100k.) That's a bit crazy, so what you do instead is you depreciate one-twentieth of it every year, and take a little hit to your profits each year.

So by year 20, when you finally get rid of it, it is worth $0 on your books and you get $0 for it. So no massive loss in one year, you've spread it all over 20 years. Which makes sense - you've used it over 20 years, so the cost of it should be spread over 20 years.

But buildings are different to tractors. Buildings keep their value, or go up in value, over 20 years.

Even though buildings don't generally depreciate (in the sense of steadily dropping in value over time), the IRS still allows you to claim depreciation each year, just like with a tractor.

Let's say you buy a building for $1,000,000. You depreciate it by some approved amount every year. So after 20 years, your building is showing on your books as worth (say) $500,000.

Then you sell it for $2,000,000.

You just made a profit of $1.5m ($2m-$0.5m), which is taxable. That's the recapturing bit: the gain you record for tax purposes is the selling price less the book value (now artificially low, because of depreciation). (It's a bit more complicated than that, but that is the crux of it)

It seems unfair, but it isn't really - you've reduced you tax bill every year for the past 20 years thanks to the depreciation you took each year. Each year that's reduced your taxable profits a little, and hence reduced your tax bill.

Happy to be corrected if I've got this wrong, but that's my best crack at understanding and explaining it.
.
Bruce,
This is also the way my accountant explained it to me.
 

Heckno

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It's stuff like this that keeps CPA's busy!
Ours basically looks at everything we've purchased for the inn for the year and tells us what's best. I think a lot of it depends on the life of the item as well. Something big and long-lived, can be spread out over a certain time frame. I think the time frame depends on the life of the item. Something with a shorter life span can be taken all at once. ie- depreciated the full amount in one year..
Madeleine said:
I think the time frame depends on the life of the item. Something with a shorter life span can be taken all at once. ie- depreciated the full amount in one year.
There were some special depreciation rules over the last few years - items that were 'accelerated', often computers and electronics. I'll have to look at the rules again for 2012 since we've purchased a bed in its entirety - that will need to be depreciated.
I still don't understand how the recapturing works and am not looking forward to having to figure that out.
.
I'm not an accountant, but I'm curious about this kind of thing, so I read up on it. Here's my understanding of how recapturing works, and why it happens.
It's easier to understand recapturing if you compare a house to, say, a tractor.

Let's say you bought a tractor for your business for $100,000. It lasts twenty years, after which it is worth $0 (to keep the numbers simple).

If you don't depreciate it a little each year, then when you finally dispose of it, you'd make a loss of $100,000 in that year. (It was worth $100,000 in your books. You sold it for $0. So that's a loss of $100k.) That's a bit crazy, so what you do instead is you depreciate one-twentieth of it every year, and take a little hit to your profits each year.

So by year 20, when you finally get rid of it, it is worth $0 on your books and you get $0 for it. So no massive loss in one year, you've spread it all over 20 years. Which makes sense - you've used it over 20 years, so the cost of it should be spread over 20 years.

But buildings are different to tractors. Buildings keep their value, or go up in value, over 20 years.

Even though buildings don't generally depreciate (in the sense of steadily dropping in value over time), the IRS still allows you to claim depreciation each year, just like with a tractor.

Let's say you buy a building for $1,000,000. You depreciate it by some approved amount every year. So after 20 years, your building is showing on your books as worth (say) $500,000.

Then you sell it for $2,000,000.

You just made a profit of $1.5m ($2m-$0.5m), which is taxable. That's the recapturing bit: the gain you record for tax purposes is the selling price less the book value (now artificially low, because of depreciation). (It's a bit more complicated than that, but that is the crux of it)

It seems unfair, but it isn't really - you've reduced you tax bill every year for the past 20 years thanks to the depreciation you took each year. Each year that's reduced your taxable profits a little, and hence reduced your tax bill.

Happy to be corrected if I've got this wrong, but that's my best crack at understanding and explaining it.
.
Hi Bruce-
I like your explanation above, but just one detail: That profit is all taxed at capital gains rates, 20% I think, whereas I offset higher taxed ordinary income. Right?
I am brand new to this and scouting a property in a beautiful place I am visiting. I have only a few days to do relevant homework and inspect the property.
Thanks,
Rick
 

undersea

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It's stuff like this that keeps CPA's busy!
Ours basically looks at everything we've purchased for the inn for the year and tells us what's best. I think a lot of it depends on the life of the item as well. Something big and long-lived, can be spread out over a certain time frame. I think the time frame depends on the life of the item. Something with a shorter life span can be taken all at once. ie- depreciated the full amount in one year..
Madeleine said:
I think the time frame depends on the life of the item. Something with a shorter life span can be taken all at once. ie- depreciated the full amount in one year.
There were some special depreciation rules over the last few years - items that were 'accelerated', often computers and electronics. I'll have to look at the rules again for 2012 since we've purchased a bed in its entirety - that will need to be depreciated.
I still don't understand how the recapturing works and am not looking forward to having to figure that out.
.
I'm not an accountant, but I'm curious about this kind of thing, so I read up on it. Here's my understanding of how recapturing works, and why it happens.
It's easier to understand recapturing if you compare a house to, say, a tractor.

Let's say you bought a tractor for your business for $100,000. It lasts twenty years, after which it is worth $0 (to keep the numbers simple).

If you don't depreciate it a little each year, then when you finally dispose of it, you'd make a loss of $100,000 in that year. (It was worth $100,000 in your books. You sold it for $0. So that's a loss of $100k.) That's a bit crazy, so what you do instead is you depreciate one-twentieth of it every year, and take a little hit to your profits each year.

So by year 20, when you finally get rid of it, it is worth $0 on your books and you get $0 for it. So no massive loss in one year, you've spread it all over 20 years. Which makes sense - you've used it over 20 years, so the cost of it should be spread over 20 years.

But buildings are different to tractors. Buildings keep their value, or go up in value, over 20 years.

Even though buildings don't generally depreciate (in the sense of steadily dropping in value over time), the IRS still allows you to claim depreciation each year, just like with a tractor.

Let's say you buy a building for $1,000,000. You depreciate it by some approved amount every year. So after 20 years, your building is showing on your books as worth (say) $500,000.

Then you sell it for $2,000,000.

You just made a profit of $1.5m ($2m-$0.5m), which is taxable. That's the recapturing bit: the gain you record for tax purposes is the selling price less the book value (now artificially low, because of depreciation). (It's a bit more complicated than that, but that is the crux of it)

It seems unfair, but it isn't really - you've reduced you tax bill every year for the past 20 years thanks to the depreciation you took each year. Each year that's reduced your taxable profits a little, and hence reduced your tax bill.

Happy to be corrected if I've got this wrong, but that's my best crack at understanding and explaining it.
.
Hi Bruce-
I like your explanation above, but just one detail: That profit is all taxed at capital gains rates, 20% I think, whereas I offset higher taxed ordinary income. Right?
I am brand new to this and scouting a property in a beautiful place I am visiting. I have only a few days to do relevant homework and inspect the property.
Thanks,
Rick
.
Also note, land was never supposed to be depreciated, only the improvements.
Also, smart people broke out parts of the house - driveways/sidewalks, heating/cooling equipment, carpeting/drapes, appliances, etc. These have different schedules as they are assumed to wear out faster.
I believe recapture applies to the leftover of the ORIGINAL - which is usually depreciated over 27.5 years.
But it definitely should be with a tax consultant/accountant. This is not the kind of thing that self-reliance makes much sense. There is a lot at stake if you screw it up.
Also, this is where a tax free exchange makes a lot of sense.
 

MtnKeeper

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The part the worries me is the gotcha of having to pay back any depreciation when I sell..........
gillumhouse said:
The part the worries me is the gotcha of having to pay back any depreciation when I sell.........
This is why we all want to die with our boots on...
.
You can always do a 1031 exchange for another investment property. Say I sell for $1.5 million and my property has been fully depreciated. I can turn around and buy an investment property which is "like kind - meaning investment/rentable" (or 2 or 3) that total the $1.5 million and not have to pay any taxes on it so long as I keep those properties for two years. So I could buy 3 $500,000 condos at the beach and rent them out. After 2 years, I could move into one of them and keep getting income from the other two.
That's why they won't have to take me out in a box.
 

Garden_Pix_Inn

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The part the worries me is the gotcha of having to pay back any depreciation when I sell..........
gillumhouse said:
The part the worries me is the gotcha of having to pay back any depreciation when I sell.........
This is why we all want to die with our boots on...
.
You can always do a 1031 exchange for another investment property. Say I sell for $1.5 million and my property has been fully depreciated. I can turn around and buy an investment property which is "like kind - meaning investment/rentable" (or 2 or 3) that total the $1.5 million and not have to pay any taxes on it so long as I keep those properties for two years. So I could buy 3 $500,000 condos at the beach and rent them out. After 2 years, I could move into one of them and keep getting income from the other two.
That's why they won't have to take me out in a box.
.
MtnKeeper is correct, as was the initial "question." (My husband is an attorney.) IF you are just setting up your B&B consider a couple of things:
1) can't deduct parts of inn you use, even for 5 sec. - so cannot deducts/depreciate hall\ways, DR, kitchen (unless you have two), etc. We have a party room/office on a separate meter for power. THAT is 100% depreciated/deducted. Only about 2/3 of the rest of the inn (historic part) can be.
2) Less you depreciate less you have to "pay back" so a balance is a good idea. Less deduction now can be better later.
3) IRS used to really go after innkeepers overdoing it (on deductions and other things) so do it by the book
4) always seek the counsel of a CPA.
5) we've used the like kind exchange to go from a duplex (sold) to vacant land. The categories are pretty broad. Get an attorney or CPA to help you. You also need a specific company which handles the transfer (for a fee).
As we just told a friend who inherited $1 million from her parents recently: Lots to know, lots to learn and lots of responsibility when you actually have money. Much easier being poor, LOL!
 

happykeeper

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The part the worries me is the gotcha of having to pay back any depreciation when I sell..........
gillumhouse said:
The part the worries me is the gotcha of having to pay back any depreciation when I sell.........
This is why we all want to die with our boots on...
.
You can always do a 1031 exchange for another investment property. Say I sell for $1.5 million and my property has been fully depreciated. I can turn around and buy an investment property which is "like kind - meaning investment/rentable" (or 2 or 3) that total the $1.5 million and not have to pay any taxes on it so long as I keep those properties for two years. So I could buy 3 $500,000 condos at the beach and rent them out. After 2 years, I could move into one of them and keep getting income from the other two.
That's why they won't have to take me out in a box.
.
MtnKeeper is correct, as was the initial "question." (My husband is an attorney.) IF you are just setting up your B&B consider a couple of things:
1) can't deduct parts of inn you use, even for 5 sec. - so cannot deducts/depreciate hall\ways, DR, kitchen (unless you have two), etc. We have a party room/office on a separate meter for power. THAT is 100% depreciated/deducted. Only about 2/3 of the rest of the inn (historic part) can be.
2) Less you depreciate less you have to "pay back" so a balance is a good idea. Less deduction now can be better later.
3) IRS used to really go after innkeepers overdoing it (on deductions and other things) so do it by the book
4) always seek the counsel of a CPA.
5) we've used the like kind exchange to go from a duplex (sold) to vacant land. The categories are pretty broad. Get an attorney or CPA to help you. You also need a specific company which handles the transfer (for a fee).
As we just told a friend who inherited $1 million from her parents recently: Lots to know, lots to learn and lots of responsibility when you actually have money. Much easier being poor, LOL!
.
Mountain City host said:
1) can't deduct parts of inn you use, even for 5 sec. - so cannot deducts/depreciate hall\ways, DR, kitchen (unless you have two), etc. We have a party room/office on a separate meter for power. THAT is 100% depreciated/deducted. Only about 2/3 of the rest of the inn (historic part) can be.
We have an entirely separate living quarters including its own kitchen. This is our private non-business space. Everything else is 100% there as our business and is completely deductible.
 

OnTheShore

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The part the worries me is the gotcha of having to pay back any depreciation when I sell..........
gillumhouse said:
The part the worries me is the gotcha of having to pay back any depreciation when I sell.........
This is why we all want to die with our boots on...
.
You can always do a 1031 exchange for another investment property. Say I sell for $1.5 million and my property has been fully depreciated. I can turn around and buy an investment property which is "like kind - meaning investment/rentable" (or 2 or 3) that total the $1.5 million and not have to pay any taxes on it so long as I keep those properties for two years. So I could buy 3 $500,000 condos at the beach and rent them out. After 2 years, I could move into one of them and keep getting income from the other two.
That's why they won't have to take me out in a box.
.
MtnKeeper is correct, as was the initial "question." (My husband is an attorney.) IF you are just setting up your B&B consider a couple of things:
1) can't deduct parts of inn you use, even for 5 sec. - so cannot deducts/depreciate hall\ways, DR, kitchen (unless you have two), etc. We have a party room/office on a separate meter for power. THAT is 100% depreciated/deducted. Only about 2/3 of the rest of the inn (historic part) can be.
2) Less you depreciate less you have to "pay back" so a balance is a good idea. Less deduction now can be better later.
3) IRS used to really go after innkeepers overdoing it (on deductions and other things) so do it by the book
4) always seek the counsel of a CPA.
5) we've used the like kind exchange to go from a duplex (sold) to vacant land. The categories are pretty broad. Get an attorney or CPA to help you. You also need a specific company which handles the transfer (for a fee).
As we just told a friend who inherited $1 million from her parents recently: Lots to know, lots to learn and lots of responsibility when you actually have money. Much easier being poor, LOL!
.
Mountain City host said:
1) can't deduct parts of inn you use, even for 5 sec.
Actually, this depends on the legal form of your business organization -- if a corporation owns the inn, then everything is fully deductible by the corporation. If it is a job requirement that the innkeeper live at the inn, then the value of the housing provided to the innkeeper by the inn corporation can be a tax-free employee benefit -- if organized as a c-corp. If the corporation is an s-corp, and the innkeeper/employee is also and owner (or closely related), then the value of the housing provided (reasonable market value) is taxable to the innkeeper/employee as part of their income (but costs are still deductible by the corporation).
 

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