The Home Office Deduction

If you are a business owner or self-employed and you use a part of your home exclusively and regularly as your principal place of business, or on a regular basis for inventory storage, you may be able to deduct some of your home expenses and reduce your tax bill. An employee that uses a part of his or her home for business use may also qualify for a deduction if the above conditions apply and:

• the business use of the home is for the convenience of the employer, and
• no part of the home is rented from the employee by the employer

If the business use of the home is merely appropriate or helpful, no deduction may be taken. To qualify for exclusive use, you must use a specific area of your home only for your trade or business. The area used for business can be a room or other separately identifiable space. You do not meet the requirements of the “exclusive use test” if you use the area in question both for business and for personal purposes. You do not need to meet the exclusive use test if you use part of your home for the storage of inventory or product samples, but to take a deduction for such use you must meet all the following tests:

• The sale of products is your trade or business.
• You keep the inventory or product samples in your home for use in your trade or business.
• Your home is the only fixed location of your trade or business (or, as an employee, it’s your only place of work).
• You use the storage space on a regular basis.
• The space you use is a separately identifiable space suitable for storage.

To qualify under the regular use test, you must use a specific area of your home for business on a regular basis. Incidental or occasional business use is not regular use.

If you use your home for a profit-seeking activity that is not a trade or business, you cannot take a deduction for business use. For example, if you are an investor and you use your home to regularly read financial periodicals and reports, conduct analysis, gather data, make trades, talk on the phone, and carry out similar activities related to your investments, you cannot take a deduction.

You can have more than one business location and still qualify for a home office use deduction as long as your home is your “principal place of business.” To determine whether your home is your principal place of business, you must consider:

• The relative importance of the activities performed at each place where you conduct business, and
• The amount of time spent at each place where you conduct business.

If, after considering your business locations, your home cannot be identified as your principal place of business, you cannot deduct home office expenses.

Figuring the Deduction

To take a home office deduction, you’ll need to figure the percentage of your home used for business. To find the business percentage, compare the size of the part of your home that you use for business to your whole house. Use the resulting percentage to figure the business part of the expenses for operating your entire home. For example, let’s say your home office is 240 square feet and your entire home is 1,200. Your business use percentage is 20%.

Next, identify the deductible expenses. They’ll fall into one of two categories:

1. Direct Expense — Expenses only for the business part of your home, such as paint and repairs to the business-only area of your home. These are 100% deductible.
2. Indirect Expense — Expenses for keeping up and running your entire home, such as insurance, utilities, real estate taxes and general repairs. These are deductible at the business use percentage of the home.

Expenses incurred to improve or enhance the non-business-use parts of your home are not deductible at all.

Depreciation Expense

If you own your home and qualify to deduct expenses for its business use, you can claim a deduction for depreciation. Depreciation is an allowance for the wear and tear on the part of your home used for business. You cannot depreciate the cost or value of the land. You recover its cost when you sell or otherwise dispose of the property. To figure your depreciation deduction, you need to locate the following:

• Month and year you started using your home for business.
• Adjusted basis and fair market value of your home (excluding land) at the time you began using it for business.
• Cost of any improvements before and after you began using the property for business.
• Percentage of your home used for business.

The adjusted basis of your home is generally its cost, plus the cost of any permanent improvements you made to it, minus any casualty losses or depreciation deducted in earlier tax years.

The calculation of the amount you can deduct in any given year is a bit complex. We suggest you give the above-noted data to your accountant and let him or her develop a depreciation schedule for you.

For more information about deductions for business use of a home, search for publication 587 at www.IRS.gov.