Americans are increasingly working at home, but many fail to claim tax deductions for home offices; they fear it will make them a target for an audit or that it will cost them when they sell their home.
That could be a mistake. The deduction can save you a lot of money if you're willing to plan carefully and keep the right records. If you're single and self-employed, with a taxable income of $60,000, you're in the 25% tax bracket. With the self-employment tax at 15.3% (for Social Security) and typical state income taxes of 5% to 6%, your tax rate is in the 45% range.
"Every dollar you can legitimately deduct saves you 45 cents," says Jeff Levine, a CPA with Alkon & Levine in Newton, Mass.
"If you can take the deduction, you should," Levine adds. "It's not really likely to provoke an audit, and the potential downside when you sell your home isn't as bad as it was. Don't do it if you don't qualify, because the penalties -- which often amount to 20% of the understated tax, plus interest -- are a killer. But if you do qualify, it's worth it."
With that in mind, our two-part series explores the ins and outs of the home-office deduction. This first part answers these questions: How do you know if you and your office qualify? How can I claim the deduction? Part Two will answer three more questions: What do I need to back up my claim? Is the deduction a red flag for an audit? And what are the downsides of taking the deduction?
Anyone who's self-employed and uses part of his or her home exclusively for business can take the deduction. The space must be your primary place of business, and you must use it exclusively and regularly for business. To be your "primary" place of business, the space must be used to meet clients, or for bookkeeping and administrative tasks.
The qualification most often questioned by the IRS is exclusivity. "If you get audited, they're going to be looking for evidence of personal activities," Mark Luscombe, principal federal tax analyst for CCH, the Riverwoods, Ill.-based publisher of the
Standard Federal Tax Reporter
. "You don't want to have a TV there, or a bunch of toys."
Many employees also qualify, but with a key restriction: The home office must be required by your employer, or be for your employer's convenience as opposed to your own.
IRS publication 587 spells out the details.
How Do I Do It?
To figure your deduction, divide the square footage of your office by the total square footage of your home. For example, if you have a 200-square-foot office and a 2,000-square-foot house, your office represents 10% of your home. As a result, you may deduct 10% of mortgage payments or rent, as well as utilities.
You also can deduct the cost of improvements and repairs to the space. For whole-house projects, you can deduct the office's percentage. "If you paint just your office, you can deduct 100%," Levine says. "If you paint your whole house, you can deduct 10% if the office takes up that percentage of the total space in your home."
One bill you can't deduct entirely is your first phone line, because it's considered personal. But you can track your business calls and deduct that amount.
You'll need to file
Form 8829, which calculates business-related home deductions. If you're unsure whether the deduction is worth it for you, you might take a look at that form, and its instructions, to get a sense of what it requires.
Coming up next: More answers about the home-office deduction
Mike Woelflein is a business and personal finance freelance writer. A former senior industry specialist with Standard & Poor's and managing editor of ColoradoBiz magazine, he has also written for The Denver Post and American Express.