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YOU MAY HAVE HEARD THAT A MAN'S HOME IS HIS CASTLE. Not always. Sometimes it's his office. Or
her office. The decade of the 90s saw millions of people change the way they work, or more precisely, where they
work. A new term, telecommuter, was born. This period also saw many displaced by merger mania, or those just
wishing to get out of the rat race, go from employee to founder of their own home-based business. In doing so,
they came in touch with that fabled myth: the home office tax deduction otherwise known to the Internal Revenue
Service as "business use of the home". Whether you are an owner or employee, there could be a new tax deduction
in your life. Let's investigate its nooks and crannies.
Qualifying for a Deduction
Only those individuals who use a portion of their residence for business exclusively and on a
regular basis can qualify for a home office deduction. In doing so, you must meet one of three tests: 1) It must
be your principal place of business; 2) It must be a place where you meet or deal with clients, customers or
patients in the normal course of business; 3) It must be a separate structure, i.e., not attached to your home but
used in connection with your trade or business. In addition, employees have to pass two additional tests: First,
the business use of your home must be for the convenience of the employer. Second, you cannot rent all or any
portion of your home to your employer and claim a deduction for that portion. Those are the rules, but what do
they mean?
Qualifying for a home office deduction depends on all the facts and circumstances. What is meant
by "exclusive," "regular," "principal" or "convenience"? Let's find out. "For the convenience of the employer" does
not mean simply appropriate or helpful. The employee who takes work home at night or who telecommutes when the
employer has provided them with office space does not qualify. In fact, most employees will not qualify for a home
office deduction. The employer would have to specifically request that you work at home. Such a case might be when
the business is located in another city and they do not want to establish a formal office. As long as you do not
rent your home office space to the employer and you meet the other requirements, you will probably qualify.
Well then, what is meant by "exclusive" and "regular"? Exclusive has its common meaning. You
cannot use the space for any other purpose. It does not have to be a separate room or marked off by partitions as
long as it is separately identifiable. Using your home office computer to check personal email or for the kids to
play video games or do their homework disqualifies you. So does using the space as a part-time guestroom. Regular
basis also has its common meaning. Infrequent or incidental use does not meet the requirements even if the use is
exclusive. However, regular use for part of the year might qualify you to deduct expenses for that portion of the
year if you have a seasonal type business.
Prior to 1999, home office deductions seemed more like a myth to most individuals whether
employee or sole-proprietor. Guidelines then followed the Supreme Court decision in the Soliman case. It struck a
very narrow definition of what a principal place of business was. The relative importance of activities performed
in the home office had to exceed those performed elsewhere or failing that, the time spent in the home office had
to exceed the time spent elsewhere. It was entirely possible that an individual would not have a principal place
of business. After 1999, Congress reacted to the outcry and expanded the definition of what qualifies as a principal
place of business. Now you can claim a home office deduction by performing administrative or management activities
at home as long as you have no other location where you substantially conduct similar activities (and, of course,
meet the other requirements).
Figuring the Deduction
So you qualify for a home office deduction, congratulations! The next step is figuring out how
much you can deduct. All home expenses may be categorized as either directly, indirectly, or unrelated to the
business use of the home. Direct expenses are only for the space used as an office. They include such things as
painting or repair or installing a telephone jack. Indirect expenses are related to the entire home. Insurance,
utilities, a new roof would be examples of indirect expenses. Mortgage interest and real estate taxes also fall
into this category. Unrelated expenses are those for the part of your home not used for business such as painting
the kitchen, repairing a leak in the basement, or lawn care when you use a spare bedroom as an office. Of course,
if you set up your home office during the year, i.e., in June, any expense prior to then does not qualify. In
figuring your deduction, the IRS has stated that the charge for basic telephone service including taxes for the
first telephone line into your home is a nondeductible expense. Long distance charges and the cost of special
features added for business purposes may be deducted.
Do not begin gloating once you have totaled up the related expenses by category. Your home office
deduction is limited by:
- The percentage of your home used for business
- Your deduction limit
Next month we will explore these concepts and on which form to show your deduction. We will
also discuss a potential tax trap from claiming a home office deduction.
Update
After our publishing deadline for the article 'Unraveling the Mysteries of Small Company Retirement Plans'
which appeared in the February issue, the elective contribution limits for SIMPLE plans was raised by $500
to $6,500 per year beginning in 2001.
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