Frequently Asked Tax Questions --January 12, 1997

This column, in slightly different format, originally appeared in The San Francisco Examiner Newspaper, Sunday January 12, 1997

 

Home-Office Deduction

ROBERT L. SOMMERS

Note: This exercise is for educational purposes only and is not intended to be legal or tax advice. Your particular facts and circumstances must be considered when applying the U.S. tax law. You should always consult with a competent tax professional with respect to your particular situation.

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Home-Office Deduction

Taxpayers may deduct the portion of their home for business ("home-office deduction"), provided the space is used exclusively and on a regular basis as (1) the principal place of business or (2) a place of business used by patients, clients or customers to conduct business. A "home" may be a house, apartment, condominium, mobile home, boat, and unattached structures (garage, studio, greenhouse or barn). A separate dwelling may qualify for business use, even if it is not the principal place of business.


An employee who uses a portion of his home for business for the convenience of his employer may deduct such use. No deduction is allowed if the employee rents the space to his employer.

The business portion of the home cannot be used for both personal and business purposes; it must be used exclusively for business. This area should not be used for family activities or as a guest room. You may, however, divide a room into business and non-business use. You may determine the proportionate share of business use in either of two ways: the amount of square footage used for business compared to the total square footage of the house (including the basement) or the number of rooms used for business compared to the total number of rooms in the house, provided the rooms are roughly the same size.

Storage of inventory or product samples, by a wholesaler or retailer using his home as the sole business location, is deductible as long as that space is used regularly for that purpose and is separately identifiable for storage use.

The home-office deduction is restricted to those pro-rata expenses associated with the business portion of the entire home (repairs, maintenance, insurance, security system costs, utilities and taxes), along with depreciation or rental payments. Basic local telephone service is not deductible (since the IRS knows you'd have the line anyway), but a second line, long-distance calls and special options (call forwarding, voice mail) relating to the business are deductible.


Computing the home-office deduction is tricky: You start with business gross income, reduced first by all deductible home-based expenses without regard to business use (home mortgage interest, property taxes, casualty losses) and then by all other direct occupational expenses (business phone, equipment, office supplies).

For example, if you have $10,000 in business gross income, with $3,000 in non-business deductions plus $6,500 in business deductions, the home-office deduction is limited to $500. In other words, expenses for the home-office cannot create a tax loss, but you may carry forward unused deductions to the following year.


According to the U.S. Supreme Court, one must compare using the home-office with all other places where business is transacted, to determine whether the home-office constitutes the "principal" place of business. The two primary factors are: (1) relative importance of the activities performed at each business location; and (2) amount of time spent at each location. Classroom teachers will be denied home-office deductions since the school is the most significant or influential place of business. A research professor, however, might claim a deduction if his research is performed at home, rather than at school.

An anesthesiologist who spends 10-15 hours a week at his home-office, but spends 35 hours a week among three hospitals, cannot claim a home-office deduction since the services performed at the hospitals comprise the most important place where services are performed. The same is true for a computer consultant who spends most of his time on the premises of his customers.

A salesperson, who spends a majority of his time calling on customers and making sales at his customers' places of business, will be denied a home-office deduction since his most important activity occurs outside his office. In contrast, a salesperson who makes most of his sales by telephone or mailing (emailing or faxing) information from his home and spends comparatively little time on the road visiting customers will be entitled to the deduction.

Personal investment activities (analyzing stocks, clipping coupons) do not comprise a business and the IRS will disallow a home-office deduction, but management of several rental properties could constitute a separate trade or business.

Once your home becomes the principal place of business, business travel to and from it becomes a deductible expense. Remember, if you sell your home, that portion dedicated to business use will not qualify for the tax-free rollover rules pertaining to a principal residence. (In general, if one sells a principal residence and acquires another of equal or greater value within 24 months, the sale is tax free.)

Taxpayers should claim home-office deductions on Form 1040, "Schedule C," and must attach Form 8829, "Expenses for Business Use of Your Home."

Home-office deductions for employees are listed under the miscellaneous itemized deduction category under "Schedule A." These deductions are subject to the 2% floor for such deductions. (In general, if your adjusted gross income is $40,000, you may deduct amounts greater than $800 - 2% of 40,000.) Statutory employees, however, may use "Schedule C" to claim these deductions.


Although many taxpayers believe a home-office deduction is a "red flag" for an IRS audit, these fears are largely unfounded. Keep good records of the expenses associated with the business use of your home. A business checking account with cancelled checks, separate telephone lines, and a diary of meetings with clients are examples of the records and documentation needed to survive an audit.




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**NOTE: The information contained at this site is for educational purposes only and is not intended for any particular person or circumstance. A competent tax professional should always be consulted before utilizing any of the information contained at this site.**