Office in Home expense
Posted on | August 14, 2009 | 3 Comments
Have you ever heard anyone, including your tax professional say, “don’t take the home office deduction because it is a red flag to the IRS?” Several years ago there was a lot of emphasis by the IRS on the Office in Home (OIH) deduction and it scared a lot of taxpayers from taking it. IRS bluster should not, however, deter you from taking a legitimate OIH deduction. You just need to know how it works and what you can legally take. As in all cases, proper documentation is essential to backup your OIH deduction.
First some definitions from the IRS: In order to claim a deduction for OIH, the part of the home used for the business must be used “exclusively” and “regularly” as your principle place of business.
- “Exclusive use” means a specific area of the home is used only for the business. To pass this test, you cannot do any personal business in that space. For example, having a TV in the room might disqualify it, unless the TV is required for the business.
- “Regular use” means the area is used regularly for the business. Incidental or occasional use is not regular use.
- If you have more than one location for your business, your home can still qualify as an OIH if it is the “Principle Place of Business.” Your OIH will qualify as the principle place of business if:
- You use is exclusively and regularly for administrative and management activities of the business, and
- You have no other location where these significant administrative and management activities can take place.
To summarize, you must set aside the space for the business and only use it for the business. Non-business profit seeking endeavors such as investment activities do not qualify for an OIH, nor do not-for-profit activities such as hobbies. If you carry on any personal activities in the area, you are not allowed the OIH deduction.
So let’s discuss how you compute the amount of Home Office Deduction you can take: Generally, the amount of the deduction depends on the percentage of the home that is used for business.
A taxpayer can use any reasonable method to compute business percentage, but the most common methods are to:
- Divide the area of the home used for business by the total area of the home, or
- Divide the number of rooms used for business by the total number of rooms in the home if all rooms in the home are about the same size.
Taxpayers may not deduct expenses for any portion of the year during which there was no business use of the home.
Example: Your home is 1800 square feet and your home office uses one room which is 120 square feet. Your business use of home is 6.7%
You may deduct expenses that are directly and indirectly related to your office. Expenses that are directly related to the office, for example, painting or re-carpeting the office are deductible in full. Other, indirect expenses are deductible based on the percentage use of the home. Examples of these kinds of expenses are rent, insurance, utilities, general repairs and security systems.
Example: Let’s say your rent is $1,200 per month, $14,400 per year. The deduction for OIH would be $14,400 X 6.7% or $964.80.
Some expenses are not deductible at all. For example, lawn services would not be deductible unless you meet clients at your home office. Painting another room in the house would not be deductible.
For those of you business owners who own your home, the same business use percentage is applied to your real estate taxes and mortgage interest; however, these are also deductible on Schedule A, Itemized Deductions. So, they would be deductible regardless.
Finally, you can take a depreciation deduction for the business use of a home you own. You cannot take depreciation if you rent. Depreciation is an allowance for “wear and tear” for the part of the home used in the business.
Caution: When you do depreciate your home, and later sell it, you must pay tax on the amount of depreciation you took. This portion of profit you make on the sale is recaptured as ordinary income, even though the home might otherwise qualify for the home sale exclusion.
Other than real estate taxes and mortgage interest if you own your home, OIH can only be taken to the extent you have a profit in your business. In other words, the OIH deduction cannot cause a loss in your business.
One last point; when you are self employed and take the OIH deduction, your home becomes your base and all mileage to and from business meetings becomes deductible. Of course, you must document that mileage. I’ll talk about that in another blog post.
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3 Responses to “Office in Home expense”
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September 9th, 2009 @ 11:39 am
That is alot of information to absorb. One think I am not clear on is whether or not I can take the OIH deduction if my office is in my bedroom. I have one side of the room that is my office (includes desk, printer, file cabinet & computer). The other side has my bed & night stand. Does that disqualify me from taking the deduction? Thanks in advance.
September 10th, 2009 @ 1:05 pm
Thank you for your question.
Every situation has to be considered on its own merits. In your situation, the space you
have set aside for your office in home would qualify. Not the entire bedroom, but the
part that you are using as the office. The “exclusive” and “regular” use rules apply to
that space. So, if your bedroom is 120 square feet and you used half of that, you would
be using 60 square feet as office, divided by the total square footage of the apartment
or whatever you are living in.
December 18th, 2009 @ 3:55 pm
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