If you think the home office tax deduction is confusing – you are right. Worse, the IRS has reversed its own position from yes to no and back to yes several times – like the infamous Florida recounts. Let’s briefly review the rules as they are today.
1. You need to have a legitimate business that makes money.
The home office deduction is part of your Business income and expenses tax form – Schedule C. If you do not run a real business (and there are rules to establish that) – than the home office does not apply. If the business is losing money, the deduction is technically available, but it will not reduce your taxes this year – you can only put it on “layaway” for future.
2. You need to have a legitimate office or storage space that you use in this business regularly.
The current rules are much better than they used to be a few years back. The office space must be identifiable but it does not have to be an entire room – a corner clearly separated by furniture will do. You are entitled to the deduction if you either use your office as principal place of business, or if you regularly meet there with customers, or if it is a separate structure like a converted garage.
3. The office space must be used exclusively for business.
This means that if you place a TV in that room or occasionally use it as a guest bedroom – the deal is off. Therefore, an entire bedroom can never qualify, only a well-defined portion of it.
Examples of people who do qualify under these rules:
- electrician who converted his extra bedroom into an office and uses it for administrative work
- lawyer who uses his den strictly to meet with clients several times a month and to study
- cosmetics distributor who allocated a closet and part of her bedroom to store samples
- landscaper keeping tools in his garage
People who do not qualify:
- tailor working part-time in her living room (not business only use)
- massage therapist treating clients at their homes and occasionally seeing someone at his house (not principal place, not used regularly)
- tutor working with her students on the breakfast table (no separate space)
I can, but should I?
Determining whether you can use the deduction is only half of the battle. The other half is deciding whether you should use it. There are disadvantages too.
- The IRS still does not like this deduction – even when perfectly legal – and using it may draw more attention to your return.
- It does complicate the return preparation and record keeping.
- Claiming home deduction can backfire when you sell the house – part of your profit will become taxable.
It is up to you to decide whether the deduction is worth the trouble.
Finally, if you decide to go ahead, you will have to comply with complex rules. For instance, you will need to divide all home expenses between personal and business parts of the house and make sure you do not double-dip. Who said taxes were created for fun?
You correctly assume that there are more rules and exceptions that we had room to describe. For example, some employees can use this benefit if they work at home on their employer’s request. In-home day-care providers are subject to special rules – and so on. If unsure about your specific situation – please consult a competent tax professional. Good luck!