Friday, March 2, 2007

3 Rules for Home Office Expense ... everybody's asking about them

As an indie in business you may work anywhere you want. You may rent an office or studio, purchase an entire building in which to set up shop, or work out of your home. Whatever suits your situation. If you happen to work out of more than one place you may be able to deduct expenses for all of them.

There’s an old husband’s tale that contends deducting office-in-the-home expense on your tax return is a red, waving flag, so don’t do it. That’s hogwash. If you use your home for your self-employed business, then, by golly, don’t be afraid to take the deduction. By deducting expenses for your home workspace you’ll pay less tax. The only caveat: play by the rules.

The IRS has relaxed the rules in recent years, and they are simpler than you may have been led to believe. There are now only three home office rules.

RULE #1: Exclusive Use
The part of your home used for business must be used exclusively for business. It does not need to be an entire room, but may be a designated area of a room.

• If Lily Legal writes her briefs at the dining room table but also has dinner parties there, well, she has to forgo any deduction for the dining room.

• If Victor Visual and his wife Faye Fabrique, a textile designer, share the same studio-in-the-home, then neither gets the deduction because neither has exclusive use. (It seems unfair, but it's true.)

RULE #2. Used On A Regular Basis
The part of your home used for business must be used on a regular basis for business.

• Almost Sargent has a rented studio in town. He also has great light in a back room of his house. The room is always locked and seldom used. Once in a while he brings a potential buyer to his home to look at a painting and he uses the back room for the viewing. This is not regular use and so he cannot deduct the use of that room as a business expense.

RULE #3. Principal Place Of Business
Your home office or studio or workshop must be your principal place of business. The IRS term principal place of business is confusing. Even if you have more than one place of business, as long as the room or area in your home is used exclusively and regularly for business then your home office qualifies as a principal place of business if it fits any of the following three criteria.

** It is where you perform administrative tasks such as bookkeeping or scheduling.

** It’s a place where you meet clients, or patients, or customers.

** It’s a separate structure.

• Sally Ceramist rents a neighbor’s garage as her work studio. It’s always a mess. She has set up the small sunroom in her home as her showcase studio. Potential buyers come there by appointment to view her work. Although her works also show at a number of galleries throughout the United States Sally can deduct the sunroom as a home office.

• Kyla Chiropractor shares an office with an acupuncturist. They alternate days. Kyla does not keep patient records at the office. Each morning she brings from home that day’s patient folders. She keeps all her patient records, and her professional library, in a small barn on her farmland home. Kyla can deduct the barn.

There are exceptions to RULE #1, which requires exclusive use. The exceptions apply to home daycare businesses and storage of inventory.

What Can You Deduct?
Your home may be any kind of residence: house; apartment; condominium; cooperative; houseboat; mobile home.

And, all expenses for the portion of your residence used for business are deductible; that includes rent, repairs, utilities, security system, and upkeep expenses. If you own the home, deductions include mortgage interest and real estate taxes. If for instance 20% of your home is used for business then you can deduct 20% of all these expenses.

You cannot deduct lawn care unless there is an area that is for the exclusive use of your business.

The housekeeper that you have agreed to pay “off the books” – the one who takes cash only -- cannot be deducted as an expense. You can deduct the costs for a legitimate cleaning service or a housekeeper for whom you pay all payroll taxes.


June Walker said...

I would like to claim home office expenses, but my apartment is a loft-like layout that makes it impossible for me to use a dedicated room as an office. I was wondering if I built a partition, a "cube" of sorts, and only used that area for work, would that be a reasonable way to establish an "exclusive" area?

Thanks much for your help and your website. It's been a terrific resource as I learn how to run my business.

Stacey, in Massachusetts

Hello Stacey,

Any way that separates your work area is fine. Could be a couple tall plants, a bookshelf, a curtain.

I'm pleased that my website is a resource. Hope that now my blog will be, too.


June Walker said...

Hello Blog Visitors,

I received the following letter from Kurt, in Utah:

I have deducted a home office in the past that I thought was used exclusively for business but worry about the idea. I have 2 sole proprietorships. One business - I do most of the business sales / customer service work and bookkeeping from the home office and deduct the % of home office according to the percentage of income derived from this office. With the other business, I use the home office space for my bookkeeping. Does this mess up the exclusive use? If so what do I do as I have deducted this home office though it does not amount to much for a few years?

After I sent an incorrect response to Kurt, he and I each did some research. Kurt found, then I confirmed with the IRS, that Kurt’s method of deducting home office for two businesses is correct.

The IRS says when you have more than one trade or business operating out of the same home office, as long as the office qualifies for each business, you may take the deduction for home office.

To calculate the portion of deduction for each business you must consider, in addition to any other relevant facts and circumstances, things like the following for each business:
Gross income
Time spent on the business
Time spent in the home office
Area typically used for specific tasks

Thank you to Kurt, who says: I never have much luck getting consistent answers from the IRS though I don't deal with them a lot. I deal with customs and importing. You want to see a jumbled, hard to interpret thing, look at the tariff codes.

Superior Baby Slings & other attachment parenting needs

Michelle said...

I am a teleworker, not self-employed. I work out of the house next door to my home, which I also own. What expenses can I deduct? I am also required by my employer to attend occasional meetings at the main office site, which is 120 miles round trip from my home office. Can this mileage be deducted on my income taxes?

June Walker said...

Hello Michelle,

If you have a legitimate home office and business miles then theoretically you may deduct the same costs as a self-employed.

Whether you actually get the deduction depends on many of the other elements of your return.

To learn what is deductible look to the left at the categories and read the applicable posts.

-- June

Anonymous said...

Hi June,

Thanks for posting on this subject. My partner and I have a general partnership in the Commonwealth of Virginia. We are not married. Business is conducted in his home office. Should the general partnership deduct for the home office or should he deduct it on his individual return? We want to be sure we are playig by the rules.
Thanks--Lisa D, Virginia

June Walker said...

Dear Lisa,

You are welcome. I think you will find your answer here --
Partnership & Home Office.

If not, let me know.

-- June

Anonymous said...

Dear June,
I have started cleaning houses this year...and will more than likely make about 12,000 dollars working part time me and my husband file jointly ..He makes approx about 50,000 a year and he is scared it will affect our return...we have 2 children we claim...What is your best advice for us filing thanks.........

June Walker said...

Dear Anonymous,

My best advice to your husband is to not be scared but to get smart.

Start by reading my blog posts and website to learn more about a self-employed business.

-- June