How to Claim a Home Office Deduction and Sleep at Night
More than half (52%) of all small businesses operate from home. It's generally assumed that if you work from home and claim a home office deduction, you're sending a red flag to the IRS and inviting an audit.
Text Size:A A A
Just because you work from home doesn't automatically mean you're entitled to claim a home office deduction. You can claim this deduction only if your home is used as:
- A place to meet or deal with customers, clients, or patients in the normal course of business.
If you use a freestanding structure on your property -- such as a studio, barn or garage -- for business, it doesn't have to be your principal place of business or a place to meet with customers; costs related to it can be a home office deduction.
Your "principal place of business" usually is the location where you spend most of your time and where you earn your money. For instance, a plumber or interior designer's principal place of business would typically be customer locations. However, the law allows you to treat the home office as your principal place of business if you use it to do substantial administrative chores, such as keeping your books, ordering supplies and scheduling appointments, and you have no other fixed location for your business, such as a storefront or office somewhere else.
Find appropriate space
Situate your home office within your residence in a work-friendly location. You need space that allows you to work comfortably and efficiently. This means space with sufficient lighting and room to include the tools of your trade, such as a desk, file cabinet and table for a copying machine. You may also need space that allows you to close a door and obtain privacy.
For tax purposes, the space in most cases must be used regularly and exclusively for business (there are special exceptions for daycare providers and for storage of inventory). This means you can't use the kitchen table to prepare meals and also create work proposals if you want to claim a home office deduction for this space.
You don't need to use a full room or even make a permanent partition of space for a home office. Just dedicate an area that you'll use only for business.
Safety net: Take a photo of your office setup and keep it with your tax records. If you are audited, the IRS may want to visit your home to see your office. If you are no longer using a home office at the time of the audit, the photo can help prove your legitimate business use of the space.
If you are entitled to a home office deduction, you can write off the costs of running your home that are allocated to business use. For example, if the house you own is 3,000 square feet and you use 300 square feet as your home office, then 10% of the expenses of the home -- mortgage interest, real estate taxes, homeowners' insurance, utilities and maintenance as well as an allowance for depreciation -- are part of your home office deduction. In addition, any direct costs related to your home office, such as painting the room used as your office, is part of the deduction.
Safety net: While you ordinarily may not retain records of personal costs, such as your utility bills, be sure to do so if you plan to claim a home office deduction. This will show the cost so you can figure the percentage that's deductible.
Some people resist claiming the home office deduction because they fear the impact it will have on the tax results of a future home sale. Fear not! Gain on the sale of a home in which there has been a home office qualifies for the full home sale exclusion (which is up to $250,000 for singles and $500,000 for joint filers); there is no allocation required because of the home office. However, any depreciation claimed on the home office after May 6, 1997, is "recaptured" and reported as capital gain at the rate of 25% when the home is sold.