by Carolyn Lieberman

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Some, maybe even many, people who would qualify for a home office deduction don’t claim it because it was for many years an “audit flag.” This article is intended as a guideline to correctly determine whether your home office qualifies for a deduction, and what you can deduct.

What qualifies? To deduct your home office, you must meet both of the following requirements:

Primary place of business: Under the original (and still the preferred) rule, the home office must be the site where you meet customers or perform the paying work. If you have another office elsewhere, you lost the deduction. If it is the nature of your business to meet clients and perform work at other locations, you may still qualify if you use the office as your principal place of business for administrative or managerial work.

Exclusive and regular use: Ideally, to meet the definition of “exclusive,” your home office is a separate room where you close the door, or even a separate structure. A clearly bounded area also qualifies, in which case it’s helpful to consolidate your work-related furnishings – desk, bookshelves, file cabinets — in one area.  To qualify, this space should be the center of your management and administrative activities, and may include space devoted to storage of products, samples, and equipment. Other factors considered in determining exclusive and regular use include the amount of time spent in your home office versus other locations, and the relative importance of the   activities carried out in your home   office. If you operate two businesses from home, each must meet the “exclusive and regular” criteria for its own area. Providing daycare in your home falls under a special set of rules, and it’s doubly advised to consult a tax professional in this case. There  are also some exceptions to the general rules when it comes to using a separate structure, or storing inventory or product samples.

If you are an employee the space must be used for the convenience of your employer – you may not have an office or desk at your employer’s place of business as well. A home office or a telecommuting arrangement must also be a requirement of your employer.

What can you deduct? A qualifying percentage of rent or mortgage interest, property taxes if you own your home, insurance, electricity, garbage pickup, security system services, and repairs and maintenance. The percentage of those costs you can claim is calculated by dividing the square footage devoted to business use by the total square footage of your home. Only include water in your utilities if water is used specifically in your business.

If you own your home, the office space is depreciated as part of your deductions, which requires calculating your investment in the structure: purchase price of the property, plus the cost of improvements, minus the cost of the land. This depreciation, however, has tax consequences when you sell your home for a profit.

Telephone and Internet service, furnishings and equipment are not part of the home-office deduction. These expenses go on Schedule C  for the self-employed, and Schedule A for employees. Home telephone expense deductions are greatly simplified if a second line is dedicated to business use.

At no time can your home office expense deduction, when combined with other business expenses, result in a loss, unless the home office is a separate structure.

Wishing you many happy returns!

Carolyn Lieberman is the office manager at BayCPAs. BayCPAs’ practitioners — Daniel R. Miller, JD, CPA, and Deborah Marion, CPA, EA — have over 50 years experience between them. You can reach BayCPAs at 650-726-7632, or toll-free at 877-526-8776.