Tax Return Considerations - Home Office Deductions

Each year, the Internal Revenue Service faces pressures from those taxpayers who legitimately utilize a portion of their home as an office. In the past, claiming a "home office" deduction, or the deductions for some of the expenses related to otherwise normal home ownership, triggered a "red flag" that would inevitably increase one's chances of audit. This was so widespread that many CPAs advised their clients not to claim these expenses, even if they were legitimate.

In recent years, the home office concept has become a way of work life for many Americans. As a result, the IRS has loosened some of the restrictions on claiming these deductions, and more importantly issued specific rules and guidelines for when a taxpayer is entitled to a home office deduction.

The result is that the deductions are available. The problem is that a professional often is required to interpret the rules as they apply to you. Here is just a brief discussion of these rules for informational purposes only.

General Rule

If you use part of your home "regularly and exclusively for business purposes," you may be able to deduct a portion of the expenses of operating and depreciating your home. After 1999, the rules for claiming these deductions became easier for taxpayers and even if you did not fit the rules in past years, you may find that you meet them now.

What does "regularly and exclusively for business purposes" mean to the IRS? It must be the principal place of your business, and it is a place that you actually meet with clients or business associates to conduct your business.

The Exclusive Use Test

The IRS has created a fictional test that requires that the portion of your home subject to deductions be properly allocated or identifiable. The easiest case is a home office. The problem is that it may only be used for business purposes and you cannot use this area for personal use. Using it for any personal use constitutes an interruption in the "regularly and exclusively for business purposes" requirement.

Multiple Office Locations

The IRS rules require that the portion of your home be the principal place of the business. Having some functions at another location(s) may not disqualify the deductions. But, the IRS is referring primarily to these "other locations" as client's offices, hotel rooms, airports, and other more temporary and less established offices. If you were to have an office in an office building, and even if you did not use it, except for minor tasks, you may face a challenge from the IRS.

Shades of Gray

Your home office:

  1. must be a regular and exclusive use that is for the convenience of your employer and not one in which your convenience is the primary reason for having the office; and
  2. a separate structure not attached to your home can also be claimed.

With respect to the rules for a separate structure, these rules are even more unclear, because the separate structure situation may not always require that you use it regularly or exclusively for business purposes.

Obviously, the IRS intent is clear - they do not want some taxpayers to deduct a portion of their home ownership expenses, while others can by claiming a business office. But, whether the rules that have been promulgated are clear is certainly subject to interpretation.

Computing the Deduction

You can decide what portion of the actual space your business use comprises when compared to the total space in your home. You ought to be prepared to document your computation of the percentage of the home used for business, in the event the IRS asks. Take the amount of space in the home and compute the actual percentage of the space used in the business office. Then you can examine the IRS rules with respect to deductions for all of the usual home ownership expenses, and deduct the percentage related to the business use.

A Word of Warning

The problem with this calculation, and with the entire home office concept, is that professional help will likely be required to place you on solid footing in taking this deduction. There are also several differences in the way businesses deduct expenses and other costs related to depreciation and capital gains. Using your home as an office and claiming such deductions may subject you to the application of these other rules, which may end up costing you more in taxes.

In short, if you start out looking for a way to deduct a portion of your home expenses, you may not be as comfortable as necessary in claiming home office deductions. If your primary reason for seeking this deduction is to deduct some real losses that you are experiencing, you may be closer to the comfort level using this area of deductions.

Posted in: Financial Law