Many people shy away from home-office deduction because the IRS sometimes takes a close look at it. The reason that they do is because many people do not fully understand the rules and miscalculate the deduction. A lot of tax preparers shy away from this deduction as well, and some will not even make their clients aware of it.
I had a young couple come to me and ask me to review their last three years tax returns, because they couldn’t understand why they owed so much money. Most of the tax liability stemmed from the wife’s business income. As I reviewed her Schedule C, I immediately asked, “where is the home office deduction?”.
As it turned out, the company she worked for decided to make her an independent contractor, and shipped her entire office, furniture, equipment, file cabinets and the like, to her home. This took up a substantial portion of her home. Nobody is more qualified to claim this deduction than she is. I amended their tax returns for three years, and reduced their tax liability by approximately $15,000.
If I had to guess, I would say that the tax preparer did not make the couple aware of this deduction, because he is afraid to have to deal with the possibility of having to respond to tax notices. He would rather keep the returns simple and shuffle thirty people a day through his office. Also, the additional work involved would raise his fee, and he may lose the client. And so instead, he hands the couple their tax returns, says, “Here you go. You owe $12,000. I’ll see you next year.” No explanation of why they owed so much or what to do about it next year. He would rather cost them thousands of dollars than make his job more difficult during his busy season.
The bottom line is this. You have a right to claim certain deductions, and the IRS has the right to ask for documentation. However, the home office deduction can not only reduce your regular tax, but your self-employment tax as well, which I’m sure many of us know can be quite substantial. If you qualify for this deduction, and you have a competent accountant to calculate it, you should not be hesitant to take advantage of it.
Below is a brief overview of the home office deduction. Please consult with a tax expert before applying any of this.
THE HOME OFFICE DEDUCTION
What qualifies as a home office?
- A space in your home that is used as your principal place of business. This need not be an entire room. You can designate a portion of one or more rooms as office space. A space in your home qualifies as a principal place of business if:
a. You use it exclusively for management and administrative purposes, such as billing, record keeping, setting up appointments, and other functions in the normal course of your business.
b. You have no other fixed location where you conduct administrative or management activities.
- A space used for business that is a separate structure and not attached to your home.
- A space in your home that is used to store inventory or product samples on a regular basis. It doesn’t have to be an entire room. You can allocate a portion of a space, such as half of your garage. However, your home must be your principal place of business.
- A space used in the business of providing daycare, even if that space is not used exclusively for that purpose.
- If you are an employee, you can claim the home office deduction, provided that you work at home as a convenience to your employer.
Types of expenses claimed as home office deductions:
- Mortgage interest and real estate taxes. Most people would probably get these deductions on Schedule A anyway. However, allocating these expenses to business income can significantly reduce your self-employment tax liability.
- Rent expense.
- Homeowners’ insurance.
- Home repairs can be allocated or, if they were specifically for the office space, can be claimed in full.
- Homeowners’ association dues.
- Common charges.
- Trash removal.
- Home security fees.
- Depreciation. This can be substantial, and it is a deduction for which there is no out-of-pocket cost. Claiming this deduction will lower the cost basis of your house, creating a larger capital gain if you sell it. However, most people will never pay tax on the gain, because of the income exemption on the sale of a principal residence. Also, if you leave your home to someone in you will, depreciation will have no effect whatsoever.
The information above is provided as courtesy of GMCoC member John Paul Simonson, CPA.
Please contact John at (845) 238-5061, or online via www.johnpaulcpa.com