Many of us are making the transition to working from a home office, and while it’s not everyone’s cup of tea, it can offer some pretty decent tax benefits for the self-employed tax payer.
The IRS presents three tests by which you can know if your desk at home constitutes a “home office”.
- You’re entitled to home office deductions if you use your home office, exclusively and on a regular basis, as your principal place of business. Questions to ask yourself in determining whether you meet this standard are: Do you use your home office for administrative or management activities of your business? Is it the most important place where you conduct your business, in comparison with all the other locations where you conduct that business?
- You’re entitled to home office deductions if you use your home office, exclusively and on a regular basis, to meet or deal with patients, clients, or customers; providing the patients, clients or customers must be physically present in the home office.
- You’re entitled to home office deductions for a home office, used exclusively and on a regular basis for business, that’s located in a separate unattached structure on the same property as your home. Examples might be an unattached garage, artist’s studio, or workshop.
- You’re entitled to home office deductions if you’re in the business of selling retail or wholesale products, your home is your sole fixed business location, and you use area specifically for storing your inventory. Expenses allocable to inventory storage space are also deductible under home office.
There are, however, some limitations to how much of a deduction you can take. The amount of your home office deductions is based on the income attributable to your use of the home office, your residence-based deduction that aren’t dependent on use of your home for business (such as mortgage interest and real estate taxes), and your business deductions that aren’t attributable to your use of the home office. But any home office expenses that can’t be deducted because of these limitations may be carried over and deducted in later years. (We can help you figure out how these limitations affect your home office deductions.)
This may seem complicated, tracking expenses and keeping adequate records can be time consuming. However, there is an easier way to consider. The Simplified Method gives you a prescribed rate of $5 per square foot up to 300 square feet. This may or may not yield a better deduction than your allocated expenses. And the good news is, you can switch your election from year to year, so you can take the best deduction each year. With this method though, there is no carryover provision as with the actual expenses method.
If you sell – at a profit – a home that contains, or contained, a home office, the otherwise available $250,000/$500,000 exclusion for gain on the sale of a principal residence won’t apply to the portion of your profit equal to the amount of depreciation you claimed on the home office. In addition, the exclusion won’t apply to the portion of your profit allocable to a home office that’s separate from the dwelling unit or to any gain allocable to a period of non-qualified use i.e. a period that the residence isn’t used as the principal residence of the taxpayer or his souse of former spouse) after Dec. 31, 2008. Otherwise, the home office won’t affect your eligibility for the exclusion.
In conclusion, we know that for our clients running a small business, or earning income as self-employed, every penny counts. That’s why we encourage you to keep track of those expenses, do the record keeping during the year so when we prepare your taxes we can make sure you get the largest home office deduction you’re eligible for. Let’s maximize your savings this year!