The Home-Office Tax Deduction

Running a business from home can save not only the cost of renting a separate office, but it can also save you tax dollars.

You may be able to take a tax deduction for business use of your home. The deduction is available not only for an office but for other business uses as well, such as a workshop or studio at home.

Basically, if you use part of your home for business and you meet the technical requirements of the tax law, you can deduct a percentage of the cost of many home-related expenses. These expenses typically include utilities, rent, insurance, depreciation, mortgage interest, real estate taxes, and some casualty losses, repairs, and improvements (if they relate to the part of the house you use for business).

According to the IRS, your "home" can be a house, condo, or apartment unit -- or even a mobile home or boat, so long as you can cook and sleep there. You can rent or own -- that doesn't matter here. But wherever you live, before you can deduct expenses for using part of your home as a business, you must meet two tax law requirements.

Requirement #1: You must regularly use part of your home exclusively for a trade or business (see Section 1, below).

Requirement #2: You must be able to show one of the following:

  • You use your home as your principal place of business (see Section 2, below).
  • You meet patients, clients or customers at home (see Section 3, below).
  • You use a separate structure on your property exclusively for business purposes (see Section 4, below).

1. Regular and Exclusive Use

The first requirement for taking deductions related to your home is that you regularly use part of your home exclusively for a trade or business. The notion of regular use is a bit vague. The IRS says it means you're using a part of your home for business on a continuing basis -- not just for occasional or incidental business. A few hours a day on most days is probably enough to meet this test.

Exclusive use means that you use a portion of your home only for business. If you use a room of your home for your business and also for personal purposes, you don't meet the exclusive use test.

Example

Brook, a lawyer, uses a den in his home to write legal briefs and prepare contracts. He also uses the den for poker games and hosting a book club. Result: Brook can't claim business deductions for using the den.

Marvin has a den he uses only for business. He also puts a business calendar, desk, and computer in his kitchen, but continues to cook and eat there as well. Result: Marvin can claim business deductions for the den, but not the kitchen.

There are two exceptions to this rule: You don't have to meet the exclusive use test if you use part of your home to store inventory or product samples, or if you run a qualified day care facility at your home. (The storage exception is discussed below. Check IRS Publication 587, Business Use of Your Home, at www.irs.gov, for the day care rules.)

2. Principal Place of Business

In addition to using part of your home regularly and exclusively for business, your home must be your "principal place of business" in order to take deductions relating to home business use. It's simple to establish that your home is your principal place of business if you conduct your business only from home.

Example
Alma teaches school. As a teacher, her principal place of business is the school where she teaches. She also runs a public relations consulting company and uses a part of her home as the headquarters for that business. Alma should be able to take the home-office deduction for this business use of the home, so long as she also meets the "regular and exclusive use" requirement discussed in Section 1, above.

If you have more than one business location, including your home, for a single trade or business, you must figure out if your home is your principal place of business for that enterprise. Your home qualifies as your principal place of business if both of these are true:

  • You conduct the administrative or management activities of your business there.
  • You have no other fixed location where you conduct those activities.

In other words, your home doesn't have to be the place where you generate most of your business income. It's enough that you regularly use it to do such things as keeping your books, scheduling appointments, doing research, and ordering supplies. As long as you have no other fixed location where you do such things -- for example, an outside office -- you should be able to take the deduction.

Example
Ellen, a wallpaper installer, performs services for clients in their homes and offices. She also has a home office that she uses regularly and exclusively to keep her books, arrange appointments and order supplies. Ellen is entitled to deduct home-office expenses for that part of her home (so long as she also satisfies the "regular and exclusive use" rule, discussed in Section 1, above).

Home-connected expenses. These IRS rules apply only to home-connected expenses such as utilities, rent, depreciation, home insurance, mortgage interest, real estate taxes, and repairs. You needn't conform to the business-use rules in order to deduct other ordinary and necessary business expenses -- for example, the cost of office supplies, postage, advertising, travel, equipment, professional memberships and publications, long-distance phone calls, and a separate business telephone line. All of those are deductions you can legitimately take, assuming you have a bona fide business that is operated for a profit.

Storing Inventory or Product Samples at Home

If you sell retail or wholesale products and you store inventory or samples at home, you can deduct expenses for the business use of your home, whether or not you use the storage space exclusively for business.

There are two limitations, however: First, you won't qualify for the deduction if you have an office or other business location away from your home. Second, you have to store the products in a particular place -- your garage, for example, or a closet or bedroom. It's okay to use the storage space for other purposes as well, as long as you regularly use it for storing inventory or samples.

Example: Jim sells heating and air conditioning filters to small businesses. His home is the only fixed location of his business. Jim regularly stores his inventory of filters in half of his basement. He sometimes uses the same area for working on his racing bikes. Jim can deduct the expenses for the storage space, even though he doesn't use that part of his basement exclusively for business.

3. Meeting Clients or Customers at Home

If your home isn't your principal place of business, you may still be entitled to deduct expenses for business use of your home if you regularly use part of your home exclusively to meet with clients, customers, or patients. Doing so even one or two days a week is probably sufficient. You can use the business space for other business purposes, too -- doing bookkeeping, for example, or other business paperwork -- but you'll lose the deduction if you use the space for personal purposes, such as watching videos.

Example
Julie, an accountant, works three days a week in her downtown office and two days a week in her suburban home office, which she uses only for business. She meets clients at her home office at least once a week. Since Julie regularly meets clients at her home office, she can take a home-office deduction, even though her downtown office is her principal place of business.

Keep a log of the clients or customers you meet at home. Good records can be key if the IRS challenges your right to deduct home-office expenses. Maintain an appointment book in which you carefully note the name of the client or customer and the date and time of each meeting at your home. Save these books for at least three years. They can be crucial to documenting business usage if your tax return is audited by the IRS.

4. Using a Separate Building for Your Business

If your home isn't your principal place of business, and you don't meet clients or customers at home, you can deduct expenses for a separate, freestanding structure that you use regularly and exclusively for your business. This might be a studio or a converted garage or barn, for example. The structure doesn't have to be your principal place of business or a place where you meet patients, clients or customers. But be sure you use the structure only for your business: You can't store garden supplies there or use it for the monthly meeting of a club.

Example
Norm is a self-employed landscape architect. He has his main office in a professional center near a shopping mall, but most weekends he works in his home office, which is located in a converted carriage house in his backyard. Since Norm uses the detached carriage house regularly and exclusively for his landscape architect work, it qualifies for the home-office deduction.

Ways to Document Your Home-Office Deduction
Here are some steps you can take to help establish your legal right to deduct home-office expenses.
  • Photograph your home office and draw a diagram showing the location of the office in your home. Keep this information in your tax folder.
  • Have your business mail sent to your home.
  • Use your home address on your business cards and stationery and in all business ads.
  • Get a separate phone line for the business.
  • Have clients or customers visit your home office -- and keep a log of those visits.
  • Keep track of the time you spend working at home.

5. How To Claim the Home-Business Deduction

If you qualify for the home-business deduction, you must figure the amount of your deduction on IRS Form 8829, "Expenses for Business Use of Your Home." Then you enter the total deduction on Schedule C, "Profit or Loss from Business." Attach both Form 8829 and Schedule C to your Form 1040 tax return.

If you plan to sell your house. Usually, if you sell a home where you've lived at least two of the last five years, the first $250,000 of profit is tax-free gain ($500,000 for a married couple). But, if you take the home-office deduction, you will always have to pay capital gains taxes on part of the profit from the sale: The amount taxed will be at least as much as the total of the depreciation deductions you took as part of the home-office deduction. If you've been taking the home-business deduction and you want to sell your house, be sure to consult your tax advisor about this potential trap, well in advance of the sale.

Tax Benefits of Business Deductions

All of the business deductions that you take -- whether under by the home-office deduction or as ordinary and necessary business expenses -- will reduce your net business income. This in turn reduces the self-employment taxes (Social Security and Medicare) that you pay on your net business income. Plus, if you run your business with the intent to make a profit but your business deductions are larger than your business income one year, you can usually take that business loss (called a "net operating loss") and use it to offset other income.

However, you cannot take a net operating loss if your "business" seldom makes a profit and is really a hobby. In that case, you allowed to take deductions only against what little income you make from the activity.

Copyright 2004 Nolo