More employers are allowing telecommuting as a work option. Additionally, these economic times cause some to work out of their homes as a way of making ends meet. Consequently, more people are working out of their homes. This article reviews the complex rules for taking a home office deduction.
Business expenses unrelated to the home are fully deductible regardless of the fact that the home is the business location. The rules contained in the rest of this article pertain only to the home itself.
Home-related expenses are allocated between non-business use and business use. The non-business portion of the home is not deductible, except when the costs qualify as itemized deductions, such as mortgage interest expense and real-property taxes.
Home office deductions are allowable only to the extent that they are covered by the business’ revenues or income. In other words, costs associated with the business use of the home cannot generate a loss that offsets other income. Expenses in excess of this net income limitation are suspended and carried forward to the next year, subject to the same limitations.
Depreciation deductions for a home office reduce the tax basis in the home. Any gain on the subsequent sale of the home caused by the depreciation deduction is not eligible for exclusion under the home sale exclusion provisions, and will be taxable currently.
To qualify for a home office deduction, you have to meet each of the following four requirements (questions):
- Is your home office used in a trade or business activity? You cannot take a deduction if you use your home for a profit-seeking activity that is not a trade or business. For example, if you use part of your home to manage your personal investments, you cannot take a home-office deduction.
- Do you use your home office exclusively for business? You must regularly use a room or other separately identifiable area of your home only for your business. You do not meet this requirement if you use the area for both business and personal purposes. For example, if your kitchen table doubles as a work space when meals are not being served, a home-office deduction is not allowed.
Another example involves a bathroom and a hallway leading to the bathroom. Customers and workers using the exclusive home office may need to use the bathroom and the hall leading to the bathroom. However, because family members also use the bathroom and hall, the bathroom and hall fail the exclusive use requirement.
Exceptions to the exclusive use test involve space used for the storage of work-related inventory or product samples, or as a day-care facility.
- Your home office must meet one of the following three tests:
A. Is your home your principal place of business? If you conduct business at more than one location, you determine your principal place of business based on the relative importance of the activities performed at each location, or the time spent at each location. Your home office also will qualify as your principal place of business if you use it regularly for administrative activities and you have no other fixed location where you conduct substantial administrative activities.
B. Is the home office used as a place to meet with patients, clients or customers in the normal course of your business? Attorneys and other professionals who maintain offices in their homes will often meet this requirement. Using your home for occasional meetings and telephone calls is not sufficient.
C. Is the portion of your home used for business activities a separate structure not attached to the dwelling unit? You can deduct expenses for a separate free-standing structure, such as a studio, garage or barn. For example, a retail business has a store as its principal place of business. Some of what is sold is assembled, grown, made, packaged, etc. in a separate structure located at the residence. The separate structure is deductible even though it is not the principal place of business and is not used to meet with customers or clients.
- If an employee, do you use your home office for the convenience of your employer? Generally, this means that the employer expects that work be done at home, either because the employer does not provide a suitable facility, or because the employer requires more prompt attention that is facilitated by the work being performed in the home.
Here is an example. A teacher is required to prepare classes, and grade papers/tests. The school provides a work area at the school that is suitable for these purposes, and does not require the teacher to perform this work at home. However, the teacher finds it more convenient to do this at the home. Even if the place at home is used exclusively for these employment-related activities, and this home office is the only place where these administrative and planning responsibilities are performed, there is no home office deduction available because the home work area is for the convenience of the employee and not the employer.
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