Rules for Home-Office Deductions

Just in time to start thinking about next year's taxes!

Many appraisers work as sole proprietors from home-based offices, and many know that IRS guidelines allow deductions for the portion of the home that is used "exclusively and on a regular basis for work in your business." All the space you use for working from home, including storage space, can qualify for a tax deduction.

"Exclusive" use means you must use the entire area—whether a single desk, a room or an entire floor—only for business and nothing else. Any personal or family use forfeits all rights to home-office deductions

Your "principal place of business" means the place where you personally meet clients or customers (phone calls don't count) or the only fixed location where you conduct your business' key administrative or management activities. There can't be another fixed location outside of your home where you conduct such activities for that business.

Some IRS-approved examples of administrative or management activities: arranging appointments; billing clients, customers or patients; ordering supplies; maintaining records; forwarding orders; and preparing reports.

You can also qualify for deductions if your employer requires you to work from home, as long as you don’t charge your employer rent. One big catch is that you can’t deduct expenses for your home office if you choose to work at home even though your employer provides you with an office. IRS Form 8829 can be used by self-employed workers to calculate the home office deduction, which should be reported on Schedule C.

Most employees are unable to satisfy the requirement that they maintain the at-home office for the convenience of their employer—"convenience" meaning that otherwise their jobs disappear. Employees can't maintain the office for their own convenience—for instance, to complete reports at night or on weekends. Dubious IRS examiners will want to see a confirming letter that says, essentially, "No home office, no job."

The amount you deduct for your home office depends on the percentage of your home used for business. (The percentage is derived by dividing the square footage of your home office by the total square footage of your home.) Simply apply that percentage to different home expenses, such as mortgage interest, real estate taxes, utilities, home repairs and maintenance and homeowner insurance premiums. These deductions are itemized on your federal tax return, thus lowering your taxable income and reducing the tax amount you owe

Another catch: You can only deduct expenses if your business generates income. Expense deductions are limited if they exceed your gross business income.

You can factor depreciation of you home into your calculations (see IRS Publication 946), but you might want to think twice before taking depreciation on your home office is that it reduces the capital gains deduction you can get when you sell a home. That could mean you’ll owe taxes when you sell, especially if you’ve lived in your home for a while.

Remember to save invoices and cancelled checks to prove what you spent in case of an IRS audit. Keep after this housekeeping regularly, so it does not spin out of control. The last thing you want is a phone call from the IRS, followed by the sickening realization that you've been jamming all of your receipts into a large "keep box" for the last 5 years.


This post is based on this article.