The home office deduction can be a valuable tax benefit for micro- and small-businesses. This deduction is highly scrutinized by the IRS and is often considered a “Red Flag” that increases the chances of your return being looked at by the IRS. That being said, I always encourage taxpayers that legitimately qualify for the deduction to claim it. This is a deduction you really want to be sure about so here is some help.
First, regardless of the purpose of the home office, the space must be used EXCLUSIVELY for business. This means that a guest room that doubles as a home office does not qualify. If your kids are allowed to store toys and play in the room, it is not a home office. This is the end of the road for many taxpayers who do not wish to commit a space in their home exclusively to business. I don’t blame you for wanting to enjoy as much of your home as possible, but you don’t qualify for the home office deduction. (There are exceptions to the EXCLUSIVELY rule for home day care and the storage of merchandise by retailers/wholesalers.)
Second, the space in your home must be used either a) to meet with clients, or b) as the principal place of business. Meeting with clients is pretty self explanatory, but what constitutes a principal place of business is a little harder. Perhaps you manufacture and sell crafts online. Certainly the space used to build the crafts is a principal place of business. However, a space used to perform administrative functions of the business (when no other office is available) is considered a “principal place of business” and allowed as a home office. This is the way many taxpayers qualify. For example, a salesman that spends his day visiting clients might return home and do all his paperwork in his home office. This use qualifies for a home office deduction.
Once you qualify for the deduction, how do you calculate the amount? Historically, all taxpayers were required to track all of their home expenses (property taxes, mortgage interest, insurance, utilities, depreciation, etc.) and then multiply that times the percentage of the home used for business. The total home office expense cannot exceed your net income and when it does a portion of the expense is disallowed. Determining exactly which type of expense is disallowed and how it is treated in the future is quite complicated and to detailed for this blog.
Thankfully, in 2013 things became much easier for home offices of 300 square feet or less. For these taxpayers, they can simply deduct $5 per square foot and that’s it! There is no need to track any expenses! However, any home office expense in excess of net income is disallowed and not carried over to the next year. Taxpayers with larger home offices still must follow the old rules and track all the actual expenses.
The Home Office deduction can be valuable and shouldn’t be ignored just because it is a red flag. Most taxpayers can determine for themselves if they qualify. Do you use a portion of your home EXCLUSIVELY to meet clients or conduct business (including administrative work)? If so, I suggest hiring a tax professional to help determine the value of the deduction and exactly how the deduction should be claimed on your return (this can vary based on whether your business is a sole proprietorship, S-Corp, or partnership.)
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