Home Office Deductions

Are you one of the 26 million[1] Americans who has a home office, and are you part of the lucky 3.4[2] million taxpayers who claim the home office deduction? If you're not among the lucky, read on. The first mistake you are making is not claiming the deduction. Many business owners have a fear that the write-off will trigger a tax audit or that the required paperwork is complicated or burdensome. Start by getting over the fear of audit.

In my 25-plus years of working with clients, I have never seen an audit triggered by a home
office deduction. As long as you meet the rules you should be fine in claiming the home office deduction. A legitimate home office can turn nondeductible personal expenses into tax deductions to reduce taxable income. The deduction for your home office cannot exceed your home-based business income.

What are the rules? The two red-letter words that matter most to deduct home-office expenses are “exclusively” and “regular use.” The second rule is “principal place of business.” What do these rules mean? Regular and exclusive use means you must regularly use part of your home exclusively for conducting business. Probably your dining room table that you clear every night for the family dinner would not meet the test, but a corner of your bedroom or a spare room could meet the test. The second test, you must show that you use the home office as your principal place of business. If you conduct business at a location outside your home, but also use your home substantially and regularly to conduct business, you may still qualify for a home office deduction. You must use the office on a constant basis, not necessarily daily. Your use of the space once a week to bill clients, pay bills, or write articles would qualify for regular use.

There are two types of deductions: direct and indirect. Direct expenses are incurred specifically on the office space. Perhaps you had the room painted and installed built-in bookcases. The cost of painting would be a direct expense, considered repairs and maintenance, and thus would be 100 percent deductible for the office in the year paid. The bookcases would be written off 100 percent over the useful life of the asset.

Indirect expenses might include a portion of the home mortgage interest, taxes and insurance, utilities, security, as well as general repairs such as HVAC repairs. How do you determine the portion for allocating indirect expenses? The ratio is home office square footage divided by the total square footage of the space. For example, the home office might be 300 sq. ft. and the total home is 3,000 sq. ft. Therefore, the portion for allocating indirect home office expenses would be 10 percent. 

It is not necessary for the office to have permanent walls to define the space, but you do need to make sure your home office is really an office. Document the space you have designated as the home office by adding a copy of the floor plan and identify the space you are using. Take a picture of the home office space and add to your tax file for that year. With any moves and changes in subsequent years you should update the calculation and documentation.

The form used to claim the deduction (Form 8829) is 43-lines long, but you only need to complete a few lines. After the first year of claiming your home office deduction, you have a model for subsequent years. In January 2013, the IRS announced a “Simplified Option” for claiming a home office deduction, providing eligible taxpayers an easier path to claiming the home office deduction.

There are some limitations on the new option, however. Homeowners using the new option cannot depreciate the portion of their homes used in a trade or business. The mortgage interest and real estate taxes can still be deducted on Schedule A without allocation of personal and business portions. The cap is $1,500 per year based on $5 per square foot for up to 300 square feet. The taxpayer still has the burden of documenting the square footage for the deduction. The new simplified option is available starting with the 2013 return.

Don’t rejoice too soon as there is a trade off: the simple option will save time, but for many taxpayers the $1,500 cap will reduce the amount claimed by completing the more complex and lengthier form. A discussion with your tax advisor should help you determine the most worthwhile method to use.

Finally, if you use the more complex Form 8829 for the higher deduction, your self-employment income might also be reduced, which also reduces your self-employment taxes. If you have a legitimate home office, the decision should be which method to use, not whether to claim the deduction at all.

If you would like a more extensive list of deductible expenses, send me an email with subject “Writer’s Deductions.”

[1] New York-based CDB Research & Consulting

[2] Internal Revenue Service tax year 2010

____________________

Photo by Byron Small

Mary Rodriguez is the founder and president of HilRod Group, a professional services firm providing financial leadership and specializing in strategic financial solutions. Mary is a Florida CPA and Fellow with the Georgia Society of CPAs with more than 25 years of accounting and finance experience. She holds the degree of Master of Accountancy and is designated a Chartered Global Management Accountant by the American Institute of CPAs. She is an active member of the Atlanta Venture Forum, the Association for Corporate Growth, and The Women's Finance Exchange. She served a two-year term on the Board of Advisors for the Georgia Small Business Development Council. She was recognized by the SBA as Women in Business Advocate of the Year and has chaired CEO roundtables for several years.
www.HilRodGroup.com
www.linkedin.com/pub/mary-rodriguez/0/5a3/762
mrodriguez@hilrodgroup.com 
404-256-9185