Investor's Business Daily, May 25th, 2007
As BlackBerrys and laptops proliferate, working from home becomes more practical. Adding to the appeal, you may be able to claim home office deductions.
Even if you don't claim a home office, you can take business-related deductions. Those can include a business phone line and office supplies.
If you do qualify for home office treatment, you can write off a portion of your housing expenses, too. That can include part of your cost for utilities, home security, homeowners insurance and so on.
You also can take depreciation deductions for the percentage of your home used for business.
You may be able to use another tax break that stems from claiming your home office. The cost of traveling to and from business-related meetings elsewhere is deductible.
Otherwise, without a home office your first and last trip of each business day might be considered non-deductible commuting.
There are several ways to calculate your home office deductions. One is to go room by room.
If you live in a 10-room house and use one as an office, you can deduct 10% of your heat, electricity and so on. And you'd depreciate 10% of your house.
Or you can figure out what percentage of your total square footage is used for business. Only living space counts. Leave that unfinished basement out of the calculation.
Say you rent an apartment with 1,000 square feet. In one room, an area five feet by 10 feet is set aside as an office. Fifty square feet is 5% of 1,000 square feet, so you can deduct 5% of your rent.
To take home office deductions, you must clear several hurdles. "You must have a space in your home you use regularly and exclusively for business," said Tom Ochsenschlager, vice president of taxation at the American Institute of Certified Public Accountants.
If your home office has a convertible couch where your mother-in-law sleeps when she visits, the room is not used only for business. Deductions may be denied.
Principal Place
After clearing the regular-and-exclusive hurdle, you must meet at least one other requirement. The most common is to make your home office your principal place of business.
If you spend most of your working hours there, that probably won't be a problem.
But you can still get home office deductions even if you spend most of your workday elsewhere. That will be the case if your home office is the only location where you do paperwork for your business.
You can spend most of your working hours visiting clients and still deduct some household expenses.
What if your home office is not your principal place of business? You still may take home office deductions if you have an area where you meet regularly with customers, clients or patients.
Or you can use a separate structure as an office. That might be a detached garage you've converted to a meeting space.
You'll still have another test to pass if you work in your home office as an employee. You must be required to work at home by your employer.
If you pass all these tests, you can take your home office deductions on IRS Form 8829.
"If you take these deductions you may run into a trap when you sell your home," Ochsenschlager said.
All of your depreciation deductions must be "recaptured." You will owe tax on your accumulated write-offs.
A simplified example can explain the process. Say you bought your house several years ago for $450,000. You have used a home office ever since.
Say you allocated $60,000 to land and $390,000 to the house. And say 10% of your house is used as an office.
So the office part of your house is valued at $39,000: 10% of $390,000.
Your $39,000 office is considered commercial real estate so it will be depreciated over 39 years. That is $1,000 of depreciation per year.
Say you have taken this deduction for six years before selling your house. You would have $6,000 worth of accumulated depreciation.
When you sell your house, that $6,000 will be recaptured at a tax rate that goes up to 25%. You would owe $1,500 in tax.
Come Out Ahead
That may not be a bad deal. Taking depreciation deductions can save you tax at rates as high as 35% each year.
If you owe tax at a rate higher than 25%, you come out ahead with this maneuver. You also benefit from tax deferral over all the years you claimed a home office.
And you are still selling your house. If you have owned it and used it as your principal residence for at least two of the five years before a sale, you can exclude up to $250,000 of profit from tax.
Married couples can exclude gains up to $500,000. So taking a home office deduction effectively provides a tasty appetizer but doesn't spoil the tax reduction main course you get to enjoy on a home sale.
