The home office deduction
One of the many benefits of working from home is the home-office deduction. Home-based workers who qualify get to deduct a portion of their expenses related to operating an office in their home. However, the rules covering the home office deduction are complex. Here, the Minnesota Society of CPAs (MNCPA) offers an overview.
Test number 1: Regular and exclusive use
To qualify for the home office deduction, there are two major tests you must meet. The first requirement is that you use your office regularly and exclusively for business. Regularly means that you use it often - not necessarily every day, but occasional or incidental use doesn't qualify, even if the room is used solely for business.
Exclusively means that you must use the space you designate as your home office for work only - which means any non-business usage of the room will disqualify the home office deduction. The only exception to the exclusivity rule applies to running a daycare center in your home or using a part of your home to store inventory or product samples.
Test number 2: Principal place of business
The second test requires that your home office be used either as a place of business to meet with clients, customers or patients in the normal course of business or your principal place of business. Your office will qualify if you spend most of your working hours there and most of your business income is attributable to your functions there.
The home office will qualify as your principal place of business if 1) it is used regularly and exclusively for business, administrative or management activities and 2) you have no other fixed location where you can do a substantial amount of this administrative work. Examples include calling customers and clients to set up appointments, billing of customers and clients, keeping books and records, and calling vendors to purchase supplies.
Special rules for employees
If you're an employee who works from a home office some or all of the time, you must meet an additional hurdle. To qualify for the deduction, the use of a home office must be for the convenience of the employer. An example of this scenario would be the employer who does not have or provide office space for the employee. Employees who work from home a few days a week to take advantage of the company's flexible workplace option are not eligible to take the home office deduction.
Determining what's deductible
When you work from a qualified home office, you can fully deduct expenses that are exclusively for your home office, such as equipment, decorating, and supplies. You may also deduct a percentage of indirect expenses that relate to your residence including mortgage interest, property taxes, utilities, homeowners insurance, general maintenance and repairs, and depreciation.
Generally, the amount you can deduct depends on the percentage of your home that you use for business. The safest method is to divide the total square footage of the house (not counting an unfinished basement or a patio) by the square footage allocated to the business. If your house is 2500 square feet and your office takes up 250 square feet of that space, then 10 percent of your indirect expenses would be deductible. Keep in mind that the amount of your home office deduction cannot exceed the net income from the business.
Claiming the home office deduction
If you are self-employed, you use Form 8829, Expenses for Business Use of your Home, to compute your home office deductions and then you report the deduction on Schedule C. Qualifying employees must treat their home office deductions, calculated on Form 8829, as miscellaneous itemized deductions, which are deductible only to the extent that they exceed 2 percent of adjusted gross income.
A CPA can help
CPAs say that establishing proof of your home office can help in the event you are audited. You can do that by using your home office address on your business cards and stationery, taking photos of your office, and installing a phone line there. Working with a CPA can help in establishing a home office that meets IRS qualifications and in claiming the deductions you deserve.
Information and resources are available to the public on the MNCPA Web site (www.mncpa.org/information) including state and federal tax forms and information and financial planning information for individuals and small businesses. A free CPA referral service is also available on the Web site or by calling 800-331-4288. The MNCPA is part of the national 360 Degrees of Financial Literacy campaign to help Americans' improve financial literacy; information and resources are available at www.360financialliteracy.org.