Taxing Times ... The Home Office Deduction
© 1999-2017 Elena Fawkner
Yay! It's tax time again (or near enough). I can't wait. Just love
this stuff. Not! OK, I know it's boring, I know your eyes glaze
over at the mere thought of all those forms and paperwork but it
has to be done so let's just bite the bullet and get on with it.
Now let's start with the fact that there's no substitute for a
qualified professional when it comes to this sort of stuff so I'm
not going to attempt a comprehensive survey of everything you
need to think about when it comes to tax and your home business.
What we're going to look at in this article is *one aspect* of home
business taxation in the U.S.: the home office deduction. By
having a working knowledge of this deduction BEFORE you hand
everything over to your accountant will not only save both of you a
lot of time (and therefore expense), you will be able to make sure
you're keeping good records for everything you need to. Although
this article considers U.S. tax law, many other countries have
enacted similar laws so if you're outside the U.S., check with your
local tax office to see what comparable deductions may be available
in your country. I know, for example, that the Australian home
office deduction is very similar.
I figured a good place to start researching this article was the IRS
itself. Clever, no? There's a pretty handy flowchart at the IRS site
that sets out quite clearly the elements you need to satisfy in
order to deduct the business use of home expenses, so we'll
just follow that. If you're interested in checking it out for
yourself, it's at http://www.irs.gov/forms_pubs/graphics/15154t01.gif.
WHAT IS A HOME?
For the purposes of the home business deduction, a "home"
means a house, apartment, condo, mobile home or boat as
well as other structures on the property such as a garage,
shed or barn. It does not include property used exclusively
as a hotel or an inn.
IS PART OF YOUR HOME USED IN CONNECTION WITH
A TRADE OR BUSINESS?
If not, you can't deduct business use of home expenses. Duh.
Stop reading now.
In order to satisfy the trade or business use test, you must use
part of your home in connection with a trade or business. So
far so good. But if you use your home for a profit-seeking activity
that is not trade or business, you cannot claim a deduction for
the business use of home expenses. A good example given by
the IRS is research you undertake for your own private
stockmarket investments. Although this is a profit-seeking
activity, you are not involved in the trade or business of
stockbroking or dealing and so you cannot claim the home
IS THE USE REGULAR AND EXCLUSIVE?
OK, this is where things get a little trickier.
=> The Exclusive Use Test
To qualify under the exclusive use test, a specific area of your
home must be used solely for your trade or business. It can be
a separate room or part of a room but it need not be marked off
by any form of permanent partition.
So, if you have an "L" shape living room/dining room area
and the dining room area is hived off as your "office" and is used
for no other purpose, then this satisfies the exclusive use test.
If, however, you clear the dining table of your papers every night
so the family can use it for dinner, you don't meet the exclusive
use test. So confine family meals to the kitchen! Easy.
=> Exceptions to the Exclusive Use Test
The only exceptions to the exclusive use test are if you use
part of your home for the storage of inventory or product
samples or as a day-care facility.
If you use part of your home for storage of inventory or product
samples, although you don't have to satisfy the exclusive use
test, you must meet all of the following tests instead:
* you keep the inventory or product samples for use in trade or
* your trade or business is the wholesale or retail selling of
* your home is the only fixed location of your trade or business;
* you use the storage space on a regular basis; and
* the space you use is an "identifiably separate space" suitable
Therefore, if you store your inventory of knitting wool for your
internet business of selling wool, knitting patterns and knitting
needles in your basement, then you will still be able to deduct
your basement expenses (or part of your basement expenses)
even though your basement is also used as a recreation or
=> The Regular Use Test
In addition to satisfying the exclusive use test, you must also
satisfy the regular use test.
This means that you must use the specific area of your home
you use exclusively for business purposes on a continuing basis.
This means more than occasional or incidental use.
IS IT YOUR PRINCIPAL PLACE OF BUSINESS?
Your home will be your principal place of business if you use
it exclusively and regularly for the administrative or management
activities of your trade or business and you have no other fixed
location where those activities are conducted.
"Administrative or management activities" include activities
such as billing customers, keeping books and records, ordering
supplies, setting up appointments, forwarding orders or writing
Furthermore, and this is a recent change in the law from 2013
onwards, even if certain administrative or management activities
are performed outside your home, you will not necessarily be
disqualified from satisfying the principal place of business test.
You may, for example, engage third parties to conduct your
administrative or management activities at other locations. An
outside bookkeeping service is one example. You may also
conduct some of your management or administrative activities
from your car on your cellphone without disqualifying your home
as your principal place of business.
Alternatively, if you conduct your business at more than one
location, whether your home can be considered your principal
place of business depends on a consideration of the relative
importance of the activities performed at each location. If this
is not determinative, you can then take into account the time
spent at each respective location.
If, after conducting this analysis, you home can be identified
as your principal place of business then, provided you also
satisfy the trade or business and exclusive and regular use
tests, you can deduct home office expenses.
IF NOT PRINCIPAL PLACE OF BUSINESS, DO YOU MEET
PATIENTS, CLIENTS OR CUSTOMERS IN YOUR HOME?
Even if you can't meet the principal place of business test,
if you use your home to meet with patients, clients or
customers in the normal course of your business, you may
still be able to claim the deduction.
You can deduct expenses for the part of your home used
exclusively and regularly for business if you physically meet
with patients, clients or customers in your home and their
use of your home is "substantial and integral" to the conduct
of your business.
This means that the use of your home for occasional
meetings and telephone calls is not sufficient as the use of
your home is not substantial and integral to your business.
IS IT A SEPARATE STRUCTURE?
You may deduct expenses for a separate free-standing structure
such as a garage if you use it exclusively and regularly for your
business. It does not have to be your principal place of business
or a place where you meet patients, clients or customers.
For example, if you're an internet consultant whose principal place
of business is at an office downtown, but you also use your garage
exclusively and regularly as your home office for reviewing client
websites and writing reports in relation thereto, you can claim the
home office deduction for expenses associated with your garage.
BRINGING IT ALL TOGETHER
To summarize, then, to qualify to deduct expenses for the business
use of your home, you must satisfy the following tests:
1. Your use of the business part of your home must be:
(a) exclusive (unless the storage of inventory or day-care
facility exceptions apply); AND
(b) regular; AND
(c) for trade or business
2. The business part of your home must be one of the
(a) your principal place of business; OR
(b) a place where you meet with patients, clients or customers
as a substantial and integral part of your business; OR
(c) a separate structure such as a detached garage you use in
connection with your business.
CALCULATING YOUR BUSINESS USE
Calculating your business use of the area of your home that
you are using exclusively and regularly for business purposes
is not complicated. First, calculate the percentage of the business
area of your home as a proportion of your total home area.
Next, add up your rent or mortgage interest, utilities, repairs and
maintenance, insurance and property taxes. Finally, multiply the
total by the percentage you calculated above. If you own your
home, you can also include depreciation on the business
portion of your home.
Note though that you cannot deduct your home office if you have
a loss from your business or if you would create a loss by
claiming the deduction. If you find yourself in this situation, never
fear. Any expenses you can't claim this year can be carried forward
to future years.
WHETHER TO CLAIM THE HOME OFFICE DEDUCTION
So, that's the home office deduction in a nutshell. Not too
difficult, is it? Should you claim it? Why or why not?
To help you answer these questions, let's wrap up with a quick
look at the pros and cons of claiming the home office deduction.
First, the big con. Claiming the home office deduction increases
your chances of being audited. So, be sure that your claim
is legitimate before you claim it because the odds are relatively
higher that the IRS will come knocking on your door. Don't let
that stop you if you have a legitimate claim that's worth claiming
though as there are some significant advantages in claiming your
home office even after you consider the fact that your mortgage
interest and real estate taxes are already tax deductible.
To begin with, deducting as business expenses what would
otherwise be personal expenses reduces not only your income
tax but also your self-employment tax. Next, if you claim for a
home office, you can deduct rent, utilities, insurance and
depreciation which you couldn't otherwise take as expenses.
Finally, a home office allows you to deduct more car expenses
because it allows you to claim the miles you drive from home
to your first business stop of the day and from your last stop
of the day back home. This would otherwise be undeductible
Tax law is not a favorite subject of many people, I hazard to
guess. But, dry and brain numbing as it is, strive to have at
least a working knowledge of the fundamentals. This can help
you structure your business from the outset in a way that allows
you to take maximum advantage of the tax laws that work in
your favor and to minimize those that may work against you if
you don't plan your tax affairs effectively. A good accountant is
your best ally when it comes to tax. This article has hopefully
given you a working knowledge of the fundamentals of the home
office deduction but consult your accountant as to your own
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Sunday, 22-Apr-2018 21:00:40 CDT