Home Office Deductions
With the advent of the home computer and the internet, more and more business executives are working out of their homes. This is quite advantageous from a business standpoint, but the ramifications of taking a home-office deduction are another matter. The rules for qualifying for a home-office deduction are quite specific, and should be carefully considered.
The first point to remember is that, in order to qualify for the home-office deduction, a specific portion or room of the home must be dedicated exclusively to the home office. In most instances, one room in the house used exclusively as an office is sufficient. Home-office expenses are deductible by a taxpayer if the home office is used exclusively and on a regular basis for any of the following:
- As the principal place of business for any trade or bring work home from the office and try to take the home-office deduction, it won't work.
- As a place of business that is used by clients, patients or customers in meeting or dealing with the taxpayer in the normal course of business. In other words, if you are having your client meetings at restaurants or other meeting places because you do not have the facilities to accommodate client or patient meetings in your home-office, you do not have a home-office deduction.
- A separate structure not attached to the home that is used in connection with the taxpayer's trade or business. If you have a separate garage dedicated solely for your mechanical business, not attached to your home, then you may qualify.
For an employee of a company to take a home-office deduction, presuming that the employer does not provide to his employee an office or a desk to conduct business, then that employee may also qualify for the home-office deduction. In this case, the home-office must be established and used for the convenience of the employer as well.
In addition, a home-office deduction is also allowable to anyone using a portion of their home on a regular basis for either the storage of inventory or samples used or held for use in the taxpayer's business of selling products at retail or wholesale, or providing qualified, licensed day care services.
A home-office must qualify as the principal place of business. In order to qualify, the "relative importance test" and the "time test" must apply. Without getting too complicate, the relative importance test requires that all business activities performed at home be compared to the business activities performed elsewhere. The time test simply requires the comparison of the amount of time spent in the home office working on business activities to the time spent at other locations.
Presuming that all of the above requirements and tests apply, a taxpayer may deduct the other expenses applicable to the home-office, such as the home computer, business travel between the home and another business location, and the business portion of other home expenses such as insurance, utilities, property taxes and depreciation.
In taking the tax deduction, the most common method of determining the home-office expenses which can be deducted is the square-footage factor. The square-footage of the home-office divided by the total square footage of the home will give you the deductible business percentage to be applied to the home expenses. There are also other methods which are acceptable to the IRS, as long as they are consistent from year to year.
There is one last significant thought to consider in your decision to take the home-office deduction, and that is the future sale of your home. Normally, a taxpayer may exclude the total gain of his home if the home is replaced within two years or if the taxpayer is over 55 years of age. But when selling your home, having used a portion of it as deductible business property, this same business percentage of your home becomes a taxable capital gain, and is excluded from the basis of your property. In other words, if you have been deducting 25% of your home for business, plan on paying taxes on 25% of the gain on your home sale. For many, the thought of paying capital gains on the business portion of their homes is enough to scare them away from taking the deduction, but one should consider all of the advantages and disadvantages before deducting their home-office.