One tax deduction that has always been controversial is the business use of a home office. Some smaller businesses are often run out of the home. Home offices can range from a table in the corner of the living room to a third bedroom converted to an office. There are a number of issues you should consider before taking the home office deduction. Since it is a deduction that can raise a red flag to Internal Revenue Service auditors, you want to be especially careful to document every test you have to pass to take this deduction.
Tests for the Home Office Deduction
One test that you usually must pass to claim a home office deduction is the exclusive use test. You must use an area of your home exclusively for business unless you are using it to store inventory. It does not have to be a separate room or even marked off by a partition. It can just be a desk in a corner. However, it has to only be used for business. This space must also regularly be used for your business.
IRS Publication 587 – Business Use of Your Home will give you more help in establishing whether or not you pass the exclusivity and regular use tests.
How Much can you Deduct?
The first issue you must face when calculating the home office tax deduction is the size of your home office. Usually, you divide the square footage of the area designated as your home office by the square footage of your home to get the percentage your office is of your home. For example, if your home is 1,000 square feet and you use your third bedroom for your home office, which is 100 square feet, your home office percentage is 10%.
After calculating the percentage of your home you use for an office, then you can start calculating your expenses. Think about your general home expenses. If your home office is 10% of your total home space, then you multiply items like your mortgage, utilities, depreciation, maintenance expenses, real estate taxes, and homeowner’s insurance by 10% and those count as your home office expenses.
You have to treat telephone usage differently. You cannot deduct the cost of the first telephone line into your house as a home office expense. If you have a second phone line that is used exclusively for business, you can deduct that line. You can also deduct a telephone line used, for example, as a dedicated fax line.
Regarding depreciation, if you first began to use your home office in 2008 and you own your own home, you have to file Federal Form 4562 Depreciation and Amortization, to calculate the depreciation deduction entered on Form 8829.
Your home office deductions cannot exceed your gross income from your business.
You file Federal Form 8829 to claim the home office deduction.
When you Sell Your Home
If you take the home office deduction, there are implications when you sell your home. It does not impact the $250,000 home sale exclusion ($500,000 on a joint return). But, any depreciation taken on a home office must be recaptured at the rate of 25% if you are a taxpayer in a tax bracket over this amount. In other words, you must report the total depreciation you have claimed on your home office when you sell your home and pay 25% tax on that amount when you sell your home.
Other deductions for your small business and how you claim them are in Income Tax Information for Small Businesses for 2008.
