New Rules Make Office-In-Home Easier to Claim
Millions of small business owners, previously unable to claim an office-in-home because of strict IRS guidelines, may now find it easier to take this deduction. New tax laws effective January 1 liberalize the home office requirements.
Prior to 1999, in order to deduct a home office, self-employed people needed to have a space that was used regularly and exclusively as either the primary place of work for the business, a place to meet with clients or customers, a separate structure not connected to the house, or the sole storage place for business inventory or product samples.
This meant that small business owners and independent contractors who used their homes for administrative work only, even if a separate room was set up and used exclusively for that purpose, were not able to take the potentially valuable home office deduction. Consultants who work primarily at clients' offices, plumbers whose principal place of work is at the job site, and psychotherapists who see clients elsewhere but do their billing at home were among those who were unable to take this deduction.
Beginning January 1, 1999, the office-in-home deduction is available not only to those who meet the old guidelines but also to self-employed people who have no other location where they conduct substantial administrative or management activities for their business. Telecommuters and other employees can take this deduction only if use of the home is for the convenience of their employer.
In order to deduct business use of a home under the new rules, there still must be a space that is used regularly and exclusively for business. The home office does not need to be a separate room, but must be a clearly definable space in which no personal activities take place.
One rule that hasn't changed is that home office expenses cannot be deducted if the business has a loss, or if deducting the home office would create a loss. However, any home expenses that can't be claimed in the current year because of a business loss can be carried over to the next year's return.
Homeowners are already able to claim the mortgage interest and real estate tax they pay but when a portion of these expenses are deducted for an office-in-home, not only is income tax reduced but there is a reduction of self-employment tax as well. Additionally, claiming a home office means that a portion of such expenses as rent, utilities, insurance, and depreciation, which could not otherwise be deducted, can now be claimed as business expenses.
Another benefit of claiming a home office is that a greater percentage of car expenses become deductible. Without an office-in-home, most taxpayers cannot claim the miles driven from home to the first business stop of the day and from the last stop of the day back home as this is considered non-deductible commuting mileage. With a deductible home office, every trip from home to another place of business is considered a trip between two business locations and is fully deductible.
In order to claim the home office deduction, the percentage of home used for business must first be calculated. Rent or mortgage interest, utilities, maintenance, real estate taxes and insurance are then added together and multiplied by the percentage of business use. Depreciation on the business portion of the home is added in. The end result is the allowable office-in-home expense, which is fully deductible as long as the business profit is at least as much as this total.
One caution to keep in mind when deciding whether to claim a home office is that taking the deduction now may have tax ramifications when the house is sold. A tax professional can provide more information about this as can a copy of IRS publication 587 "Business Use of Your Home."
There are a number of hoops to jump through in claiming the office-in-home deduction. Despite the problems, this can be a valuable deduction and one worth considering.
Jan Zobel, EA is a San Francisco tax professional who specializes in working with self-employed people. More details about claiming an office-in-home and other business deductions are included in her book Minding Her Own Business: the Self-Employed Woman's Guide to Taxes and Recordkeeping.
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