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Business Planning

Tax Deductions for Your Home Office

Entrepreneurs, small business owners, and those who work at home may be considering utilizing the home office deduction when they file their taxes this year. This deduction can be advantageous, but there are several requirements that must be met before you can claim it as your own.

The Internal Revenue Service (IRS) has exacting guidelines that your business must meet in order to qualify for the home office deduction. For starters, let's address the word "home." As far as the IRS is concerned, "home" can refer to your house, apartment, condominium, boat, or even mobile home. After establishing that your "home" qualifies for the deduction, you must also meet certain tax law requirements. In order to claim a home office deduction, your business must adhere to the following:

Regular and Exclusive Use. According to the IRS, the part of your home that you claim for business must be used exclusively for business purposes, and on a regular basis. If you are a lawyer, for example, who does paperwork at night in your living room where the rest of the family also socializes, then you will not qualify for the deduction. However, if you have a spare bedroom that has been converted into a home office, which you use regularly for business purposes only, the room will most likely satisfy the requirements.

If you use part of your home for business storage purposes, then you may not have to meet the "exclusive" part of this rule. You can claim business use if you fulfill all of the following: 1) Your trade or business is selling products wholesale or retail; 2) You store inventory or product samples in your home for your business; 3) Your home is the only fixed location of your business; 4) Your storage space is used for storage on a regular basis; and 5) The space you use is suitable for storage, and can be identified as a separate space. For example, if you sell mechanical equipment out of your home and use half of your attic for storage, then you may satisfy these requirements.

If you run a daycare business from your home, then you need not meet the "exclusive" requirement. In this case, when you file your taxes you will have to compute the percentage of your home used for daycare, as well as the amount of time the space is available for use for this purpose. IRS Publication 587 can provide you with further information on this topic.

After fulfilling the first requirement, you must also meet at least one of the following stipulations:

  1. Your Principal Place of Business. If your business is 100% home-based, then you should be all set. However, if you have more than one location for your business, your home must be the only place available to you for performing the administrative and managerial aspects of the business. But those who have primary jobs and secondary businesses can still meet the requirements. For example, if you are employed as a teacher, but run your own jewelry business from your home, you may still qualify.
  2. Where You Meet with Customers, Clients, etc. If you regularly meet with customers, clients, or patients in an area of your house that is exclusively used for this purpose, then you may fulfill this requirement.
  3. A Separate Structure. A building on your property—used only for business—would meet this condition. This means that if you are an artist, for example, and you convert a shed into a studio, then you would probably qualify. Once again, the rule remains that this structure cannot be used for other purposes, such as storing garden and lawn equipment.

But what if you work at home on projects supplied by your employer? In order to qualify for the deduction in this scenario, your work at home must be for the convenience of your employer. This means that if your employer provides you with a place to do your work, but you choose to work at home, then you do not qualify. Such an example would be for your convenience and not the employer's. Also, in order to qualify for the deduction, your employer may not provide you with additional compensation, such as rent, for your home office space.

Once you have determined that your home-based business meets the prerequisites you will move on to the computation aspect of the deduction. Expenses that you might deduct can include: rent; utilities; deductible mortgage interest; real estate taxes; insurance; depreciation; painting; and repairs. Usually the deductible amount of these expenses is related to the percentage of floor space used by your home business. If 20% of your home is used for business, then you might be able to deduct 20% of your expenses.

There are two more things that you will have to bear in mind if you claim a home office deduction. First, if you are a homeowner and sell your home, the depreciation that you claimed on your home office must generally be applied to reduce the basis of your home and taxed. In addition, if you have made insufficient personal use of your home, you may have to prorate the exclusion of gain that would otherwise be available. Second, it is important to note that you cannot cause or increase a business loss by deducting amounts whose deductibility depend on your home office. Consult a tax professional for specific guidance. The home office deduction involves many rules, but if you qualify, it can be well worth your time and effort.

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