Home Office Deduction Can Lower Your Tax Bill, but Strict Rules Apply

Test Number 1: Regular and Exclusive Use

To qualify for the home-office deduction, taxpayers must meet two major tests. The first requirement is that the office is used regularly and exclusively for business. Regular use means the office is used often, although not necessarily every day. The space will not qualify for the deduction if it is used only occasionally, even if it is used only for business. Exclusively means that the office must be used for work only; any non-business use of the space will disqualify the worker from taking the home-office deduction. The only exceptions to the exclusivity rule apply to taxpayers who run a daycare center in their home or use a specific part of their home to store inventory or product samples.

Test Number 2: Principal Place of Business

The second test requires home offices to be used either as a place to meet with clients, customers or patients in the normal course of business or as the principal place of business. The home office will qualify as the principal place of business if 1) it is used regularly and exclusively for business, administrative or management activities and 2) there is no other fixed location where a substantial amount of this administrative work can be done. Examples of administrative work include calling customers and clients to set up appointments, billing customers and clients, keeping books and records and calling vendors to purchase supplies.

Special Rules for Employees

Employees who work from home offices must meet an additional hurdle. To qualify for the deduction, the home office must be for the convenience of the employer and the employer must provide documentation to the employee verifying it is the employer's decision and not an option of the employee. An example is an employer who does not provide office space for the employee and who is on a regular travel schedule. Employees who work from home a few days a week under a flexible workplace arrangement are not eligible to take the home-office deduction.

Determining What Is Deductible

Expenses such as equipment, decorating and supplies can be fully deducted if they are used exclusively for a qualified home office. A percentage of indirect expenses related to the residence, including mortgage interest, property taxes, utilities, homeowners' insurance, general maintenance, repairs and depreciation, may also be deductible.

Travel Costs

A key advantage of having a home office is that travel expenses from your front door to your client's office are deductible. As an employee, travel to your first meeting of the day or from your last meeting to your home is considered commuting and is not deductible. As always, IRS recordkeeping rules must be considered and a log of your travel expenses is necessary to substantiate the mileage expenses.

Calculating the Deduction

Generally, the amount that can be deducted depends on the percentage of the home used for business. The safest method is to divide the total square footage of the house (not counting an unfinished basement or attic or a patio) by the square footage allocated to the business. If the house is 2,500 square feet and the office takes up 250 square feet, then 10 percent of indirect expenses would be deductible. Keep in mind that the amount of the home-office deduction cannot exceed the net income from the business.

Claiming the Home-Office Deduction

Self-employed workers use Form 8829, "Expenses for Business Use of your Home," to compute home-office deductions and report the deduction on Schedule C. Employees must treat their home-office deductions, calculated on the worksheet in IRS Publication 587, "Business Use of Your Home," as miscellaneous itemized deductions, which are deductible only to the extent that they exceed two percent of adjusted gross income.

A CPA Can Help

CPAs say that establishing proof of your home office can help in the event of an audit by the Internal Revenue Service. Do that by using the address of the home office on business cards and stationery, taking photos of the office, and installing a separate telephone line there. Working with a CPA can help you set up a home office that meets IRS qualifications and helps you claim the eligible deductions.

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Copyright 2010 The American Institute of Certified Public Accountants