04/07/09: Deducting For Your Home Office
By Benny L. Kass
Q: I work from home a lot and have heard that there are deductions that I can take. I obviously would like to save as much money as possible in today’s economy. What are the rules regarding these home office deductions?
A: The law is very complicated and you must discuss the pros and cons with your own tax advisor. You may have to recapture (i.e. give back to the IRS) some of your deductions when you ultimately sell the property. More importantly, I suspect that the IRS carefully reviews all home office deductions they find on our income tax returns.
Are you self-employed or do you work for a company? Depending on your situation, there are different legal requirements, so let’s start with “self-employed”.
First, your work space must be exclusively used for your business. This means that you or your family cannot use the space for any other purpose. The IRS gives this example: “you are an attorney and use a den in your home to write legal briefs and prepare client’s tax returns. Your family also uses the den for recreation. The den is not used exclusively in your profession, so you cannot claim a deduction…”
Next, you must use the area on a regular basis. Typical of the IRS, they rely on what they call the “facts and circumstances” test; each case is different. But if you only sporadically use the area for your business purposes, it may not qualify for the deduction. The burden will be on you to prove “regularity”.
Finally, the home office must be your “principal place of business”. Let’s say you have more than one business location, including your home. To qualify your home as the “principal place”, you have to keep track of the amount of time spent in each place. Furthermore, according to the IRS, you have to consider the relative importance of the activities performed at each place. For example, you are a plumber. Although all of your work is done in other people’s homes, you keep your books, do your research and billing from your home. Such administrative and management activities will allow you to claim a home deduction, assuming that you meet the exclusive and regularity tests.
If you are employee, in addition to meeting the above-mentioned tests, your business use must be for the convenience of your employer. Merely working at home for your benefit will not qualify you for that home office deduction.
Once you are satisfied that your space meets these tests, how do you determine the amount you can deduct? First you have to determine the percentage of your house that is being used as a home office. You can either divide the square foot area of your space by the total area of your home, or – if all of the rooms in your house are substantially equal — divide the number of rooms uses for your business by the total number of rooms in the house.
What can you deduct? First, as a homeowner, you have the right to deduct mortgage interest and real estate taxes. You also can deduct – based on the percentage interest determined above -such expenses as insurance, utilities, security system, and general repairs. Under no circumstances, however, can you include such items as lawn care, painting a room not used for your business, or replacing that ancient washer-drier (unless of course you use it for your business).
The IRS gets very picky about telephones. The basic local telephone service charge, including taxes, for the first line into your house is considered personal, and not deductible. Long distance calls used for business and the cost of a dedicated second line can be claimed as business expenses.
Perhaps the biggest problem with taking a home office deduction is determining the amount of depreciation that you can report. Depreciation will be allowed since it takes into consideration wear and tear on your office space. To determine depreciation, you must know the tax basis of your home (and its fair market value) at the time you began using the office. And you need careful records to prove when you started that home office.
This column cannot fully explain all of the elements of depreciation. You should know, however, that when you sell your house, any depreciation you claimed after May 6, 1997, will require you to forfeit some of the up to $500,000 (if you file a joint tax return or up to $250,000 for single files) exclusion of gain that you would normally be entitled to take. According to the IRS, “when figuring the gain you can exclude, you must reduce the total gain by any depreciation allowed or allowable on the part of your home used for business after May 6, 1997.”
And, whether or not you actually claimed a depreciation deduction, if it would have been allowed, you must adjust your tax basis accordingly. This is perhaps one of the major reasons why you should give serious consideration as to whether you really want to claim that home office deduction. You may save a few dollars this year, but lose out later when selling your house.
If you decide that you really want to claim this deduction, you must fill out form 8829, entitled “Expenses for Business Use of Your Home”. To assist you with this form, also get the IRS instructions, as well as Publication 587, entitled “Business Use of Your Home”. All these documents can be downloaded free from www.irs.gov.