The
Taxpayer Relief Act of 1997 included a modification of the IRS's
definition of "principal place of business" that will permit a larger
number of taxpayers to qualify for the home-office deduction. For tax
years beginning after 1998, the deduction will be available for home
offices that are used for administrative or management activities
related to the taxpayer's business (for example, billing, maintaining
records, ordering supplies, scheduling appointments, creating reports).
Business/Personal Boundaries
Home-based
businesses, by their very nature, often have less structure. While many
consider this to be an advantage, working at home can be a double-edged
sword. The lack of structure tends to result in home-based workers
putting in more hours than when they did not work at home. Having set
office hours and "closing up" at the end of the day will help you
balance business and personal matters.
Under the amended rules, a
taxpayer is allowed to deduct expenses of a home office that is used for
business purposes only if the space is used "exclusively" on a "regular
basis" as:
The principal place of business carried on by the taxpayer,
A place for meeting with clients or customers in the ordinary course of business, or
- A
place for the taxpayer to perform administrative or management
activities associated with the business, provided there is no other
fixed location from which the taxpayer conducts a substantial amount of
such administrative or management activities.
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The Taxpayer Relief Act of 1997 added this third provision to the definition of principal place of business.
The
exclusive-use test will be satisfied if a specific portion of the
taxpayer's home is used solely for business purposes or inventory
storage. The regular-basis test is satisfied if the space is used on a
continuing basis for business purposes (that is, incidental business use
will not qualify.)
In determining the principal place of business
(first provision under the definition of principal place of business,
above), the IRS considers two factors: Does the taxpayer spend more
business-related time in the home office than anywhere else? Are the
most significant revenue-generating activities performed in the home
office? Both of these factors must be considered when determining the
principal place of business.
Employees
To qualify for
the home-office deduction, an employee must satisfy two additional
criteria. First, the use of the home office must be for the convenience
of the employer (for example, the employer does not provide a space for
the employee to do his/her job). Second, the taxpayer does not rent all
or part of the home to the employer. Employees who telecommute may be
able to satisfy the requirements for the home-office deduction.
Expenses
Home office expenses are classified into three categories:
Direct Business Expenses
relate only to the taxpayer's business activity (for example, supplies,
salaries). Expenditures for additional phone lines, long-distance
calls, and optional phone services for the business may be deductible as
direct business expenses. However, basic local telephone service
charges (that is, monthly access charges) for the first phone line in
the residence generally do not qualify for the deduction.
Permissible Expenses
are expenditures that could be included as itemized deductions in the
individual's tax return (for example, mortgage interest, real estate
taxes, and casualty losses).
Previously Non-deductible Expenses would not be deductible if not for the home office deduction (for example, insurance, utilities, and depreciation).
Limitation
Home
office deductions are limited to the gross income from the business
activity. Previously non-deductible expenses cannot create or increase a
net loss from a business activity. However, a carryover to future years
is available for unused, allowable home-office expenses.
Sale of Residence
Tax
rules generally permit a $500,000 (married filing jointly) or $250,000
(single or married filing separately) exclusion on the gain from the
sale of a primary residence. If part of the home is used for business
purposes, the gain is divided into two parts -- personal-use portion
(the exclusion applies) and business-use portion (exclusion does not
apply). For example, a taxpayer who qualifies for the exclusion, but has
used 25 percent of the home for business purposes during the during
past five years, will only be able to apply the exclusion against 75
percent of any gain recognized on the sale of the home.
As with
many tax laws there are exceptions to this rule. If you'd like a clearer
picture of the size of the exclusion you qualify for, please call us.
Taxes
The
"office-in-home" tax deduction is valuable because it converts a
portion of otherwise nondeductible expenses (for example, utilities and
homeowners insurance) into a deduction. The treatment of home offices
for income tax purposes is one of the more controversial provisions in
the tax law.
An individual is not entitled to deduct any expenses
of using his/her home for business purposes unless the space is used
exclusively on a regular basis as the "principal place of business." The
IRS applies a 2-part test to determine if the home office is the
principal place of business.
Do you spend more business-related time in your home office than anywhere else?
Are the most significant revenue-generating activities performed in your home office?
If
the answer to either of these questions is no, the home office will not
be considered the principal place of business, and the deduction will
not be available.
Business use of the home by an employee must
also be for the convenience of the employer. These rules make it very
difficult for an employee to qualify for the deduction.
If these
three tests are met, the deduction is limited to the gross income from
the business activity. Furthermore, a deduction for home-office expenses
cannot create or increase a net loss from the business. Any disallowed
deduction may be carried over to future years.
Taxpayers taking a
deduction for business use of their home must complete Form 8829. Some
tax experts believe that taking a deduction for home-office expenses,
whether clearly allowable or not, increases the likelihood of an IRS
audit.
These are some thoughts to consider.
If you have a home office or are considering one, please call us. We'll be happy help you take advantage of these deductions.