The home office deduction is a confusing topic for many taxpayers. Is it only for the self-employed? What if you’re not self-employed, but work at home frequently? And isn’t it true that the IRS is more likely to audit you if you take the deduction? Because of these types of questions, thousands of taxpayers neglect to take the home office deduction that they are entitled to each year.
The home office deduction can be taken by anybody who uses their home, or part of their home, for business purposes. Of course, because it is the IRS, there are strict guidelines which the use of the home must fall into in order to qualify. The most important of these is what the IRS calls the “exclusive and regular basis” clause. This means that the part of your home you are deducting must be used exclusively and regularly for either administration or management activity of your business, and that you have no other fixed location (for example, an office downtown) where you conduct this same business.
“Exclusive” is a key term in the IRS’s dictionary. By exclusive they mean that the part of your home you are deducting is used only for business. For example, if you have a computer in the family room that you use for sending out invoices, but your kids also use it to surf the Web or play video games, the family room does not qualify for the home office deduction. However, if, in the family room, you have a desk in the corner that nobody uses except for you, and when you do it is only for business, you can take this a home office deduction. But remember, it can only be used for business. If you use the area to pay the cable bill, send email to your brother in Chicago, or read novels, the deduction is no longer available. There are some exceptions to this: if, for example, you use part of your house to store inventory (samples of merchandise, for example) you might be able to take the home office deduction even if you don’t conduct business at home. Also, if you are a licensed day-care provider, you can take the home office deduction even for parts of the house that you use for non-business expenses.
Having a home office doesn’t necessarily mean that the declared space needs to be where you meet clients or do actual work that you get paid for. The IRS has determined that if you use your home office – again, on an exclusive and regular basis – for administrative or management chores such as sending out invoices, maintaining spreadsheets, setting up appointments, or writing reports, then you would qualify for the deduction. Again, the most important thing to remember is to keep your work space separate. Don’t sit on the couch confirming appointments and don’t sit in your home office calling your parents (unless it has to do with your business).
Because of these restrictions, it is usually much easier for self-employed workers to take the home office deduction, assuming they have properly set up an area of the house which would qualify. However, if you are an employee who works at home, there is also a chance that you may qualify. In order to qualify, you must meet the “convenience-of-employer” test. This essentially means that the work you do at home must be at the request or convenience of your employer. If this is the case, you may qualify for the deduction assuming all of the other rules regarding exclusivity and regularity are followed.
Think you qualify? If so, self-employed workers need to file IRS Form 8829, and employees who are filing Form 1040 need to use the worksheet on Publication 587 in order to determine what their deductions are. If you do qualify, there are a number of expenses you can deduct from your taxes. Essentially, any expense directly or indirectly related to the use of your home office can be taken off your taxes. By direct expenses, the IRS mean any expense that is immediately connected with your business. Supplies, maintenance of the office, equipment, computers, and books for your professional library are all considered direct expenses. For example, if installed new carpeting in your home office, this would count as a direct expense. If you installed carpeting in your bedroom, it would not. If you have a separate phone line that is used exclusively for business, or a separate Internet service, this would also qualify as a direct expense (if they are shared, you’d have to calculate how much you use for your business and take off a percentage).
By indirect expenses the IRS means expenses that are connected with the upkeep and running of your home. This allows you to take off part of your rent, house payments, and utilities, based on what percentage of the home your office takes up. For example, let’s say that your office is 25% the square footage of your entire apartment. If your rent is $1000 a month, then you would be eligible to deduct 25% of that cost as an indirect expense, or $250. The same goes for utilities such as gas and power. Going back to the carpeting example, if you paid an installer to carpet your entire home, you could take off 25% of that cost as a home office deduction.
There are two caveats to keep in mind when taking the home office deduction: First, you can only take expenses for the part of the year that you used the home office. For example, if you started your business in September, you can only take expenses from September on for that part of your home. Second, you can only take a home office deduction up to the point that your income is zero. You cannot take a deduction to claim a loss. For example, if you have $8,000 in income, but $9,000 in expenses, you cannot deduct all $9,000 from your taxes. However, the IRS does allow you to carryover the remainder of the unused deductions to the next year, and apply it to those taxes, up to the same deduction limit.
For many taxpayers, the idea of a home office deduction is a tempting but dangerous thought. For years tax experts have warned their clients that taking a home office deduction will lead to an audit, and because of this many taxpayers have decided that it is not worth the supposed risk. This is a mistake, however; any deduction you are entitled to you should take, regardless of whether or not you think the IRS will take notice. If you keep accurate records, and honestly can say that you use your home for business, then you will have no problem whatsoever.
