Housing Counsel

Read IRS Rules Carefully Before Taking a Home-Office Deduction

By Benny L. Kass
Saturday, April 11, 2009

Q: I work from home a lot and have heard that there are tax deductions that I can take. What are the rules?

A: You may be entitled to a home-office deduction, but before you take it, talk the decision through with your own tax adviser. When you sell the property, you may have to recapture some of your deductions -- that is, pay back the government. More important, I suspect that the Internal Revenue Service carefully reviews all home-office deductions.

Are you self-employed or do you work for a company? Depending on your situation, there are different legal requirements, so let's start with people who are self-employed.

First, your work space must be exclusively used for your business. This means that you or your family cannot use the space for anything else. The IRS gives this example: "You are an attorney and use a den in your home to write legal briefs and prepare clients tax returns. Your family also uses the den for recreation. The den is not used exclusively in your profession, so you cannot claim a deduction."

Next, you must use the area on a regular basis. As it often does, the IRS relies on what is known as the "facts and circumstances" test; each case is different. But if you use the area for your business only sporadically, it may not qualify for the deduction. The burden will be on you to prove "regularity."

Finally, the home office must be your "principal place of business." Say you have more than one business location, including your home. To qualify your home as the "principal place," you have to keep track of the amount of time spent in each place.

Furthermore, according to the IRS, you have to consider the relative importance of the activities performed at each place. For example, say you are a plumber. Although all of your work is done in other people's homes, you keep your books at home and do your research and billing there. Such administrative and management activities allow you to claim a home deduction, assuming that you meet the exclusivity and regularity tests.

If you are an employee, in addition to meeting the tests above, your business use must be for the convenience of your employer. Merely working at home for your benefit will not qualify you for that home-office deduction.

Once you are satisfied that your space meets these tests, how do you determine the amount you can deduct? First you have to determine the percentage of your house that is being used as a home office. You can either divide the square footage of your space by the total area of your home, or -- if all of the rooms in your house are substantially equal -- divide the number of rooms used for your business by the total number of rooms in the house.

Deductions for your home office are in addition to the deductions you as a homeowner are entitled to for mortgage interest and real estate taxes. You can deduct -- based on the percentage interest determined above -- such expenses as insurance, utilities, security system and general repairs. Under no circumstances can you include items such as lawn care, painting a room not used for your business, or replacing that ancient washer-dryer (unless you use it for your business).

The IRS gets very picky about telephones. The basic local telephone service charge, including taxes, for the first line into your house is considered personal, and thus not deductible. Long-distance business calls and the cost of a dedicated second line can be claimed as business expenses.

Perhaps the biggest problem with taking a home-office deduction is determining the amount of depreciation that you can report. Depreciation will be allowed because it takes into consideration wear and tear on your office space. To determine depreciation, you must know the tax basis of your home (and its fair market value) at the time you begin using the office. You need careful records to prove this.

This article cannot fully explain all the elements of depreciation. You should know, however, that when you sell your house, any depreciation you claimed after May 6, 1997, will require you to forfeit some of the capital gains tax break you would normally be entitled to take.

And, whether or not you actually claim a depreciation deduction, if it would have been allowed, you must adjust your tax basis accordingly. This is perhaps one of the major reasons why you should seriously consider whether you really want to claim that home-office deduction. You may save a few dollars this year, but lose out later when you sell your house.

If you decide to claim this deduction, you fill out Form 8829, "Expenses for Business Use of Your Home." You should read the IRS instructions for the form as well as Publication 587, "Business Use of Your Home." All of these can be downloaded free from http://www.irs.gov.

Benny L. Kass is a Washington lawyer. For a free copy of the booklet "A Guide to Settlement on Your New Home," send a self-addressed stamped envelope to Benny L. Kass, Suite 1100, 1050 17th St. NW, Washington, D.C. 20036. Readers may also send questions to him at that address or contact him through his Web site, http://www.kmklawyers.com.

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