If you have a business office or shop located at your residence, you are entitled to deduct household expenses allocable to that "business area."
In the past, some taxpayers abused this deduction, so the 1976 Tax Reform Act set strict qualification guidelines for this tax break. If you meet the tests, whether you own or rent your residence, there is no reason not to use this tax-saving opportunity.
Any taxpayer who uses part of his or her residence for an office or shop, or for rental to tenants, such as college students, may qualify. Taxpayers who rent their residence may be eligible to deduct part of their rent and other expenses.
The first qualification test requires a "business area" of your residence that is used exclusively for business. An example is a separate room or specifically designated area that is not also used for personal use, such as TV viewing or family activity. In other words, part-time personal, nonbusiness use of the same area disqualifies the taxpayer from using this deduction.
The second test requires the exclusive business area also to be either a) your principal business location or b) used to meet clients, customers or patients. If you are an employe, in addition, residence business use must be "for the convenience of the employer."
That means your employer must require you to work at home, usually evidenced by lack of suitable work space at the employer's business location.
If you meet these tests, then part of the operating expenses of your residence become tax deductible as business expenses. Examples of such partly deductible expenses are utilities, insurance, repairs and upkeep costs.
Even if you don't itemize your personal income tax deductions, these items can be deducted as business expenses.
Costs applicable to just the business area, such as painting your office at home, are fully deductible as a business expense. Another example is your business telephone line.
But expenses that apply only partially to the business area such as heating, electricity and insurance are only partly deductible as business costs. For example, if your home business area occupies one-fifth of your residence, then one-fifth of applicable household expenses can qualify.
If you own your personal residence, it normally doesn't qualify for depreciation deductions. But if part qualifies for business use, then that portion can be depreciated. Depreciation is a non-cash bookkeeping tax deduction for wear, tear and obsolescence of real and personal property used in a trade or business.
The depreciation deduction for residence business use depends on the residence's basis. This is the lower of its purchase price (minus land value that cannot be depreciated), plus capital improvements added during ownership, or market value of the residence on the day business use began.
After determining basis, the next step is to estimate the residence's remaining useful life, usually between 20 and 40 years. The last step is to depreciate the residence's business area, such as one-fifth of the total floor area.
Depreciation calculations can become complicated, so consultation with an experienced tax adviser is suggested to set up the depreciation schedule. The extra expense of doing so should pay off in maximum tax dollar savings if your situation qualifies for the business-at-home tax deduction.
There is one income tax benefit that property owners hope they never have to use. But when the right circumstances occur, it pays to know about the casualty loss deduction.
To qualify for this tax deduction, a loss must occur which is "sudden, unexpected, or unusual." Examples include fires, floods, earthquakes, smoke, blasts, accidents, broken water pipes and thefts.
Nonqualifying examples, which are too slow to qualify for the sudden, unexpected, or unusual criteria, include rust, termite damage, tree disease, well contamination and carpet beetle damage.
The casualty loss is an itemized income tax deduction. For each event, the first $100 of the net loss is nondeductible if the property affected is the taxpayer's personal residence. The $100 floor doesn't apply to business property.
To compute the casualty loss, use IRS Form 4684. Using this form, the amount of the casualty loss will be the lesser of 1) the owner's adjusted cost basis for the property, or 2) the decrease in its value due to the loss.
"Adjusted cost basis" means the property's purchase price, plus capital improvements added during ownership, minus any previously deducted casualty loss or depreciation. "Decrease in value" means the difference in the property's fair market value before and after the casualty loss.
From the amount of loss, subtract any insurance or other amount received, and the $100 nondeductible floor for nonbusiness losses. The result is the deductible casualty loss amount.
The IRS can require proof of the loss, such as a police report to confirm a theft loss or an appraisal to confirm the amount of damage to the property. Before-and-after photographs can be excellent proof of loss evidence. If the item can be repaired, its repair cost is usually acceptable as the amount of the casualty loss.
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