The Office-in-Home Deduction
January 19, 2001
Because of a Supreme Court case (Soilman) and some changes made by the Taxpayer Relief Act of 1997, there is still a good bit of confusion regarding the office-in-home deduction. Granted, it can get a little complicated, but the deduction is available to more and more people every day -- both self-employed folks and employees alike. So, it's not something that should be completely overlooked or dismissed.
The tax code generally does not allow a deduction for personal, living, and family expenses, including expenses and losses attributable to a dwelling that you occupy as a personal residence. But, if you're using a portion of the home for certain business uses, part of your home expenses will qualify for a deduction if:
If you're reading closely, you see the terms "regular use" and "exclusive use." These are really technical terms, and you'll need to understand their meaning if you want to secure the office-in-home deduction.
- You exclusively use a portion of your home on a regular basis as your principal place of business; or
- The home is used by patients, clients, or customers in meeting or dealing with you in the normal course of your business; or
- You have a separate structure that is not attached to your home, and are using that separate structure in connection with your trade or business.
Regular use means that the area used for your business is used on a continuing basis for that purpose. The occasional or incidental business use of the area doesn't meet the regular use test, even if it is used for no other purpose. So, if you have an office in your home, you must use it as such on a continuing basis... not just from time to time, as you please.
Exclusive use means that a specific part of your home is used for business purposes only. (There are two exceptions to this exclusive use rule for the storage of inventory and for daycare facilities, but we'll talk about those exceptions in our next installment, "The Office-In-Home Deduction In Action.") And when the IRS says "business purposes only," they mean exactly that. You might do a lot of business work on your kitchen table, but you also have breakfast and dinner on your kitchen table. Because of your personal use, the kitchen table area isn't used "exclusively" for business purposes, and doesn't qualify for the office-in-home deduction.
Well, that's all fine if you're self-employed, but what about if you're an employee and you have an exclusive office in your home that you use regularly? Are the rules the same for you? Nope, there are additional restrictions. In the case of an employee, the home office deduction is allowable only if, in addition to satisfying the exclusive and regular use tests, the home office is for the convenience of your employer.
Still not quite clear on the concept of "convenience of employer"? It basically means that your employer doesn't provide you with a place to do the appropriate work. Generally, if you're an employee and you could do the work at your employer's office, but you decide to work at home because it's convenient for you, you likely don't have an office-in-home deduction.
Think that you might have an office-in-home deduction? Not so fast! The rules also limit the amount you can deduct for business use of your home to the gross income you derived from your trade, business, or employment, LESS your normal business expenses. In other words, if your business already shows a loss on your tax return, the office-in-home deduction will not be allowed to increase that loss. In short, the office-in-home deduction is only allowed when you have net income from the business after taking your gross income and reducing that by your normal business expenses other than your office-in-home deduction.
Example: Say that you run a lint-ball removal service from your basement. Your total gross business income for the year amounted to $5,000. Your normal business deductions (other than your office-in-home deduction) such as auto expense, advertising, lint removal brushes, etc. total $5,200. Even if you meet all of the other tests, you'll not qualify for the office-in-home deduction.
But, in this case, the deduction isn't lost. It's simply suspended into next year, when you might have a net business profit. So even if your business shows a loss, it's important to "run the numbers" for the office-in-home deduction. And if you can't claim the deduction this year, you'll want to complete the appropriate forms to secure the deduction for some year in the future when the lint-ball removal business picks up.
Finally, a provision in the Taxpayer Relief Act of 1997 now makes it easier for many folks to claim the office-in-home deduction. As we noted above, the office must be your principal place of business. Because of the Soilman court case, the rules defining your principal place of business were very strict. But, because of the provisions in the 1997 tax act, your home office will qualify as a principal place of business if:
Examples of "administrative or management" activities include: billing customers, clients, or patients; keeping books and records; ordering supplies; setting up appointments; forwarding orders; or writing reports.
- The office is used exclusively and regularly for administrative or management activities of your trade or business; and
- There is no other fixed location where you conduct these activities.
Can't think of when these rules might apply? Well, think about an independent sales representative. She's out all day calling on clients. Most of her actual "work," what she does to make money, is done away from her home and home office -- meeting with potential customers at their location.
But, at the end of the day, she returns to her home office and processes paperwork, does her accounting, places her orders, and calls on appointments for the following day. Under the old rules, she would not qualify for an office-in-home deduction, but under the new rules, she has her office-in-home deduction firmly in hand. She has no other office or "fixed" location where she can conduct her business, and she uses her home office regularly and exclusively. So she's golden!
As you can see, the rules can get tricky, but I hope that they are a bit clearer for you now. In the next installment, we look at "The Office-In-Home Deduction In Action" -- how the computations and calculations actually work.