Gregory J. Cook, EA, CPA Accredited Tax Advisor

Thinking about working at your home? With the internet and computer technology, the ability for many workers to perform their regular work duties from their home is increasing at a rapid rate. Employers are looking at this option closer with the economic downturn causing many companies to aggressively seek any cost savings measures.

Tax Breaks for Office in the Home

There are good tax breaks (deductions) available for persons who maintain an office in their home, but the rules are specific and strict. For example, you can't use your dining room as an office and get the deductions. The office must be used exclusively for business.

Home Office Deduction: Basic Requirements

Generally, expenses related to the rent, purchase, maintenance and repair of a personal residence may not be deducted as a business expense. However, taxpayers who use a portion of their home for business purposes may be able to take a home office deduction if they meet certain requirements. Expenses that may be deducted include the business portion of real estate taxes, mortgage interest, rent, utilities, insurance, painting, repairs and depreciation. Note: The amount of depreciation deducted, or that could have been deducted, decreases the basis of your property.

In order to claim a deduction for that part of a home used for business, taxpayers must use that part of the home:

• Exclusively and regularly as their principal place of business, as a place to meet or deal with patients, clients or customers in the normal course of their business, or in connection with their trade or business where there is a separate structure not attached to the home; or
• On a regular basis for certain storage use such as inventory or product samples, as rental property, or as a home daycare facility.

In addition, taxpayers working as employees can claim this deduction only if the regular and exclusive business use of the home is for the convenience of their employer and the portion of the home is not rented by the employer.

“Exclusive use” means a specific area of the home is used only for trade or business. “Regular use” means the area is used regularly for trade or business. Incidental or occasional business use is not regular use.

Non-business profit-seeking endeavors such as investment activities do not qualify for a home office deduction, nor do not-for-profit activities such as hobbies.

Example: An attorney uses the den in his home to write legal briefs or prepare clients’ tax returns. The family also uses the den for recreation. The den is not used exclusively in the attorney’s profession, so a business deduction cannot be claimed for its use.

These requirements are discussed in greater detail in Publication 587, Business Use of Your Home.

Computing the Amount of Home Office Deduction

Generally, the amount of the deduction depends on the percentage of the home that is used for business. The deduction will be limited if gross income from the business is less than the total business expenses.

A taxpayer can use any reasonable method to compute business percentage, but the most common methods are to:

• Divide the area of the home used for business by the total area of the home, or
• Divide the number of rooms used for business by the total number of rooms in the home if all rooms in the home are about the same size.

Taxpayers may not deduct expenses for any portion of the year during which there was no business use of the home. If the gross income from business use of the home is less than the total business expenses, the deduction for certain expenses is limited. Publication 587 includes examples, worksheets and additional information on computing the allowable deduction.

Personal Expenses Are Not Business Expenses

It is important for taxpayers to realize that business expenses may be deducted only if they are ordinary and necessary for the particular type of business. Personal, family and living expenses are not deductible under any circumstances. A common error is to deduct expenses for a portion of the home that is not used regularly and exclusively for business.

Example: The basic local telephone service charge, including taxes, for the first telephone line into a home is a nondeductible personal expense. However, charges for business long-distance phone calls on that line, as well as the cost of a second line into a home used exclusively for business, are deductible business expenses.

The IRS encourages taxpayers to familiarize themselves with the requirements before taking a home office deduction and to keep complete and accurate records to substantiate deductions. According to IRS research, understated business income, including underreported receipts and overstated expenses, is an area where compliance is a concern. In addition to increasing outreach and education in these areas, the IRS will also be focusing enforcement efforts, including examinations, on these issues.

Here are five important things the IRS wants you to know about claiming the home office deduction.

1. Generally, in order to claim a business deduction for your home, you must use part of your home exclusively and regularly:
 
• As your principal place of business, or
• As a place to meet or deal with patients, clients or customers in the normal course of your business, or
• In the case of a separate structure which is not attached to your home, it must be used in connection with your trade or business

For certain storage use, rental use or daycare-facility use, you are required to use the property regularly but not exclusively.

2. Generally, the amount you can deduct depends on the percentage of your home that you used for business. Your deduction for certain expenses will be limited if your gross income from your business is less than your total business expenses.

3. There are special rules for qualified daycare providers and for persons storing business inventory or product samples.

4. If you are self-employed, use Form 8829, Expenses for Business Use of Your Home, to figure your home office deduction. Report the deduction on line 30 of Schedule C, Form 1040.

5. Different rules apply to claiming the home office deduction if you are an employee. For example, the regular and exclusive business use must be for the convenience of your employer.