Office in the Home

The home office needs to be used 100% exclusively for business purposes.
It also needs to be used on a regular basis as the principal place of business.

Note: if the business operations carried on at the home office are that of an S-Corporation, a C-Corporation, or an Employer who issues the homeowner a Form W-2 for wages paid, then there are strict limitations that generally deny this tax deduction by the homeowner.  A work-around that may be used is that the homeowner sends a bill (or a chit) seeking cash reimbursement from the company (the business) for an appropriate percentage of the home’s expenses (such as: mortgage interest, property taxes, rent, insurance, utilities and inside maintenance).

You need to determine the square footage of the office room

You need to determine the square footage of the home’s living area as follows:  total sq. ft. of the structure, less the stairways, landings, closets and so forth.

__________
Take a few pictures of the office each year and keep them, in case there’s an audit

You should be able to document how the office is used, how often it is used. It needs to be used with “regularity” meaning possibly a minimum of three or four days a week and for 10 hours of more per week. A log book showing the time spent in the office is helpful.

For trading activity, this doubles to show that trading also was does with “regularity” and with “continuity.” For trading, the time spent should be for a good part of most every day watching and trading the markets during trading hours. Research done before trading hours and after trading hours, while helpful, is likely not enough to achieve trader status.

Generally, other than the costs for mortgage interest and property taxes, the annual deduction is limited to the net trade or business income of the business associated with the home office.  The excess is carried forward to use against future year’s net trade or business income.

Each year, list all the expenses which will be allocated using the percentage determined from the above square footage results:

  • Mortgage Interest
  • Real Estate Property Taxes
  • Home Owner’s Insurance
  • General Inside Repairs and Maintenance
    • ○ If patients, clients or customers regularly visit, then outside yard & grounds maintenance too
  • Security System
  • Utilities
  • Heating Oil
  • Rent
  • Co-op Maintenance Fees
  • Condominium Common Charges
  • Homeowner Association Dues

Alternatively starting with 2013, annually, you elect to use an optional simplified method to calculate the home office expense deduction. The deduction is calculated based on $5 per square feet of the home office, up to 300 square feet and there are no complications with recapturing depreciation in the year of sale for the years this simplified option is used..

IRS Publication 587 Business Use of Your Home

IRS Form 8829 Instructions Expenses for Business Use of Your Home.

Business use of an automobile traveling from home office

Rev. Rul. 99-7 Circumstances where daily transportation between residence and work location is deductible

Telephone is usually listed separately. The first phone line coming into the home is not deductible for the basic fees and local phone calls IRC §262(b). Separately listed long-distance charges for the business can be deductible. A second line for the business can be deductible.


Depreciation
Improvements, Additions, Major Construction may be capitalized and depreciated over 39 years. Likewise the initial purchase price may be allocated between Land/Building Lot and the Structure leaving the Structure to be depreciated over 39 years.

Depreciation (Allowed or Allowable)
Some people say taking the depreciation deduction is a no-brainer. And under current law, if that law remains unchanged until you sell your home, it likely is a no-brainer. But history tells us that every three to ten years the law regarding the Office in the Home is turned upside down and a whole new ball game begins. (update the 1997 law was changed for sales of taxpayer’s residence after 12/23/08 and again for sales after 2008)

 

Here is an example of what the Depreciation deduction allows you:
Purchase price $750,000
Value of an improved building lot in that area. $325,000
Value remaining allocatable to the structure: $425,000
Kitchen remodeling $25,000
Depreciable amount $450,000

39 years life = $11,538 per year

sq ft of office: 144
sq ft of the home’s living area 3,800
ratio of 144/3800 = 3.79%

Depreciation deduction 3.79% of $11,538 = $437

Assumed federal income tax rate 35%
35% of $437 = $153 in your pocket.

Hey $153 is still $153!
But consider this alternative: Take your special someone out to a nice dinner once per month spending $65 or more on wine and a fine meal. Have an substantial, earnest business discussion about your business as you are waiting for the meal to arrive. 12 months @ $65 + tip = $875 or more. $875 for business meals deductible at 50% @ 35% = $153 in your pocket.

Question
I have a home office. Can I deduct expenses like mortgage, utilities, etc., but not deduct depreciation so that when I sell this house the basis won’t be affected?

Answer

Regular Method – No, all allowed or allowable depreciation must be considered at the time of sale. You can generally figure depreciation on the business use portion of your home up to the gross income limitation, over a 39 year recovery period and using the mid-month convention. As long as you determine actual expenses and the correct amount of allowed or allowable depreciation, the depreciation reduces the basis of your home accordingly, whether or not you actually claim it on your tax return.
https://www.irs.gov/faqs/sale-or-trade-of-business-depreciation-rentals/depreciation-recapture/depreciation-recapture-3


For sales or exchanges on or after December 24, 2008 – The $250,000 exclusion will not apply to any part of the residence that is not used as a principal residence if that part of the residence is separate from the rest of the residence. (Regs. §1.121-1(e)(1) (generally effective for sales or exchanges on or after Dec. 24, 2002). No allocation required if both the residential and nonresidential portions are within the same dwelling unit.)
For sales or exchanges after December 31, 2008 – The $250,000 exclusion will also not apply to gain allocated to periods of nonqualified use. (Regs.1 §121(b)(4)[5], added by P.L. 110-289, §3092(a) )

More information is found in IRS Publication 587 – http://www.irs.gov/pub/irs-pdf/p587.pdf
A special exemption to the “allowed or allowable” rule for depreciating the office is found around page 16.

The complications of electing to depreciate the structure and improvements are found in IRS Publication 523 – http://www.irs.gov/pub/irs-pdf/p523.pdf
To avoid these complication, a special exemption to the “allowed or allowable” rule for depreciating the office is found around page 16.

 

121(d)(6) RECOGNITION OF GAIN ATTRIBUTABLE TO DEPRECIATION. —

Subsection (a) shall not apply to so much of the gain from the sale of any property as does not exceed the portion of the depreciation adjustments (as defined in section 1250(b)(3)) attributable to periods after May 6, 1997, in respect of such property.”

“1250(b)(3) DEPRECIATION ADJUSTMENTS. –The term “depreciation adjustments” means, in respect of any property, all adjustments attributable to periods after December 31, 1963, reflected in the adjusted basis of such property on account of deductions (whether in respect of the same or other property) allowed or allowable to the taxpayer or to any other person for exhaustion, wear and tear, obsolescence, or amortization (other than amortization under section 168 (as in effect before its repeal by the Tax Reform Act of 1976), 169, 185 (as in effect before its repeal by the Tax Reform Act of 1986), 188 (as in effect before its repeal by the Revenue Reconciliation Act of 1990), 190, or 193). For purposes of the preceding sentence, if the taxpayer can establish by adequate records or other sufficient evidence that the amount allowed as a deduction for any period was less than the amount allowable, the amount taken into account for such period shall be the amount allowed.”

Therefore, the only home office depreciation that needs to be recaptured upon sale of a primary residence is the depreciated actually deducted by the taxpayer.


When the business is an entity, but the office is in the home of the owner of the entity:

If you are an owner the entity you have several choices for handling the costs of a qualifying home office:

  • You might be able to deduct the costs as an unreimbursed employee business expense, incurred as a condition of employment. Deducted on Schedule A, these are an itemized deduction and are only deductible to the extent that the total of such expenses exceed 2% of your Adjusted Gross Income.
  • The entity can pay you rent for the home office. The entity might deduct the rent expense, the owner would pick up the rent expense (basically a wash) and then your expenses/depreciation are then deducted. There are numerous complications and limitations using this method.  IRC §280A generally may limit the tax benefits in this situation.
  • The entity might reimburse you for the out-of-pocket costs of a home office under an accountable plan.
  • The entity might require the owners to provide a home office as a condition of ownership.


There are additional restrictions prohibiting the deduction when the entity is a corporation.


Generally, expenses related to the rent, purchase, maintenance and repair of a personal residence may not be deducted as a business expense. However, taxpayers who use a portion of their home for business purposes may be able to take a home office deduction if they meet certain requirements. Expenses that may be deducted include the business portion of real estate taxes, mortgage interest, rent, utilities, insurance, painting, repairs and depreciation. Note: The amount of depreciation deducted, or that could have been deducted, decreases the basis of your property.

In order to claim a deduction for that part of a home used for business, taxpayers must use that part of the home:

  • Exclusively and regularly as their principal place of business, as a place to meet or deal with patients, clients or customers in the normal course of their business, or in connection with their trade or business where there is a separate structure not attached to the home; or
  • On a regular basis for certain storage use such as inventory or product samples, as rental property, or as a home daycare facility.


In addition, taxpayers working as employees can claim this deduction only if the regular and exclusive business use of the home is for the convenience of their employer and the portion of the home is not rented by the employer.

“Exclusive use” means a specific area of the home is used only for trade or business. “Regular use” means the area is used regularly for trade or business. Incidental or occasional business use is not regular use.

Non-business profit-seeking endeavors such as investment activities do not qualify for a home office deduction, nor do not-for-profit activities such as hobbies.

Example: An attorney uses the den in his home to write legal briefs or prepare clients’ tax returns. The family also uses the den for recreation. The den is not used exclusively in the attorney’s profession, so a business deduction cannot be claimed for its use.

These requirements are discussed in greater detail in Publication 587, Business Use of Your Home.

Computing the Amount of Home Office Deduction

Generally, the amount of the deduction depends on the percentage of the home that is used for business. The deduction will be limited if gross income from the business is less than the total business expenses.

A taxpayer can use any reasonable method to compute business percentage, but the most common methods are to:

  • Divide the area of the home used for business by the total area of the home, or
  • Divide the number of rooms used for business by the total number of rooms in the home if all rooms in the home are about the same size.

Taxpayers may not deduct expenses for any portion of the year during which there was no business use of the home. If the gross income from business use of the home is less than the total business expenses, the deduction for certain expenses is limited. Publication 587 includes examples, worksheets and additional information on computing the allowable deduction.

Personal Expenses Are Not Business Expenses

It is important for taxpayers to realize that business expenses may be deducted only if they are ordinary and necessary for the particular type of business. Personal, family and living expenses are not deductible under any circumstances. A common error is to deduct expenses for a portion of the home that is not used regularly and exclusively for business.

Example: The basic local telephone service charge, including taxes, for the first telephone line into a home is a nondeductible personal expense. However, charges for business long-distance phone calls on that line, as well as the cost of a second line into a home used exclusively for business, are deductible business expenses.

The IRS encourages taxpayers to familiarize themselves with the requirements before taking a home office deduction and to keep complete and accurate records to substantiate deductions. According to IRS research, understated business income, including underreported receipts and overstated expenses, is an area where compliance is a concern. In addition to increasing outreach and education in these areas, the IRS will also be focusing enforcement efforts, including examinations, on these issues.

Author A.J. Cataldo, Ph.D., CPA, CMA has written articles promoting the good sense in depreciating the home office. A couple can be found here: Deducting The Home Office and Who Cares About Recapture

Forbes has an article Claiming A Home Office Deduction? It’s Much Easier This Year, Here’s How


Five Facts about the Home Office Deduction

With technology making it easier than ever for people to operate a business out of their house, many taxpayers may be able to take a home office deduction when filing their 2009 federal tax return next year.

Here are five important things the IRS wants you to know about claiming the home office deduction.

1. Generally, in order to claim a business deduction for your home, you must use part of your home exclusively* and regularly:

  • As your principal place of business, or
  • As a place to meet or deal with patients, clients or customers in the normal course of your business, or
  • In the case of a separate structure which is not attached to your home, it must be used in connection with your trade or business


*For certain storage use, rental use or daycare-facility use, you are required to use the property regularly but not necessarily exclusively.

2. Generally, the amount you can deduct depends on the percentage of your home that you used for business. Your deduction for certain expenses will be limited if your gross income from your business is less than your total business expenses.

3. There are special rules for qualified daycare providers and for persons storing business inventory or product samples.

4. If you are self-employed, use Form 8829, Expenses for Business Use of Your Home, to figure your home office deduction. Report the deduction on line 30 of Schedule C, Form 1040.

5. Different rules apply to claiming the home office deduction if you are an employee. For example, the regular and exclusive business use must be for the convenience of your employer.

Nice blog: Home Office Deduction 101