A provision in the Taxpayer Relief Act of 1997 made it easier for many taxpayers to claim the home office deduction beginning in 1999. Prior to 1999, the home office deduction was only available to taxpayers who could meet the strict interpretation of the principal place of business requirement set forth in the Soliman decision.
You may be accustomed to claiming an income tax deduction for only your mortgage interest and property taxes as a personal deduction on Schedule A. However, if you qualify for the "Office in the Home" deduction, you may be able to file Form 8829 and claim the business percentage of all the other expenses associated with operating and maintaining your home, such as; rent, depreciation, homeowners insurance, security system, repairs and maintenance, water, sewer, garbage removal, snow plowing and utilities.
Note: Lawn care/landscaping expenses are not deductible according to IRS Publication 587. However, the Tax Court has allowed deductions in Hefti, TC Memo 1988-22 and Neilson (1990) 94 TC 1.
Direct Expenses vs Indirect Expenses
Direct Expenses benefit only the business part of the home. Included are painting or repairs made to the specific area or room used for business. 100% of direct expenses are generally deductible against business income. Indirect Expenses benefit both the business and personal parts of the home. Included are the upkeep and running of the entire home. The business percentage of indirect expenses are generally deductible against business income. The business percentage of an indirect expense may be different than the business percentage determined in Part I of Form 8829.
Example: Joe uses 10% of his house for business. His electric bill is $800 for lighting, cooking, laundry, and TV. A reasonable estimate of the bill for lighting is $300. Assuming the cooking, laundry, and TV have nothing to do with business, the deductible expense for electricity is $30 ($300 x 10%). Although Joe uses 10% of his house for business, he can only deduct 3.7% of his electric bill for business purposes ($30 divided by $800=3.7%).
Home Equity Loan Interest: Interest tracing rules do not apply for purposes of deducting home equity loan interest on Schedule A (Form 1040). However, if part of the interest is considered a business deduction under the business use of home rules, the interest tracing rules apply. If the home equity loan proceeds were used to purchase a car or boat or other personal use asset, none of the interest can be considered an indirect business use of home expense.
Use Tests - The area used for business must be used "regularly" and "exclusively":
- As the principal place of business (including administrative use); or
- As a place to meet or deal with clients in the normal course of the business; or
- In connection with the business if it is a separate structure not attached to the taxpayer's personal residence.
If you are an employee claiming home office expense ...
In addition to tests (1), (2), or (3) under "Use Tests" on the previous tab, the business use of an employee's home must be for the convenience of the employer. The employee may not deduct home office expenses if all or part of the home is rented to the employer and the rented portion of the home is used to perform services as an employee of the employer. Employees deduct business use of home expense on Form 2106 and Schedule A.
Business Use of Home Deductibility - Whether an Employee or Self-Employed Individual These Definitions Apply
Regular Use: The area used for business is used on a continuing basis. The occasional or incidental business use of the area does not meet the regular use test, even if it is used for no other purpose. Exclusive Use: A specific part of a taxpayer's home is used for business purposes only. Two exceptions to this rule are: (1) storage of inventory or product samples; and (2) day care facility. Exception to the exclusive use test can be met if: Inventory or product samples are stored for the business, Business is a wholesale or retail business, Home is the only fixed location of the business, Storage space is used on a regular basis or Space used is a separately identifiable space. A taxpayer operating a day care service in the home may deduct a portion of the dwelling even if it is not set aside exclusively for the business. A room can be a living room at night and a playroom by day. The day care must be a regular business, not an occasional one.
A school cannot be run under the cloak of a day care center-the services must be primarily custodial. If the state or local government requires a day care provider to be registered or licensed, a nonlicensed day care provider cannot deduct the business use of a home unless the provider has applied for a license and has not been turned down. Providers that are exempt from state or local government licensing requirements (such as those caring for only one or two children) may still claim business use of home deductions.
Principal Place of Business, Including Administrative Use
Beginning January 1, 1999, a home office will qualify as a principal place of business if: 1) The office is used exclusively and regularly for administrative or management activities of a trade or business; and 2) There is no other fixed location where the taxpayer conducts these activities.
Examples of administrative or management activities include:
- Billing customers, clients or patients.
- Keeping books and records.
- Ordering supplies.
- Setting up appointments.
- Forwarding orders or writing reports.
Under the new rules, the following activities will NOT disqualify a home office as a principal place of business:
- Taxpayer has others perform administrative or management activities at locations other than taxpayer's home. Example: Another company does taxpayer's billing from its place of business.
- Taxpayer conducts administrative or management activities at places that are not fixed locations of the business, such as a car or a hotel room.
- Taxpayer occasionally conducts minimal administrative or management activities at a fixed location outside the home.
- Taxpayer conducts substantial nonadministrative or nonmanagement business activities at a fixed location outside the home. Example: A taxpayer meets with or provides services to customers, clients, or patients at a fixed location of the business outside the home.
- Taxpayer has suitable space to conduct administrative or management activities outside the home, but chooses to use the home office for those activities instead.
Examples of Office in the Home Deduction
Example #1: John is a self-employed plumber. Most of John's time is spent at customers' homes and offices installing and repairing plumbing. He has a small office in his home that he uses exclusively and regularly for the administrative or management details of his business, such as phoning customers, ordering supplies, and keeping his books. John uses a local bookkeeping service to bill his customers. John's home office qualifies as his principal place of business for deducting expenses for its use. His choice to have his billing done by another company does not disqualify his home office as his principal place of business.
Example #2: Pamela is a self-employed sales representative for several different product lines. She has an office in her home that she uses exclusively and regularly to set up appointments and write up orders and other reports for the companies whose products she sells. She occasionally writes up orders and sets up appointments from her hotel room when she is away on business overnight. Pamela's home office qualifies as her principal place of business for deducting expenses for its use. The fact that she conducts some administrative or management activities in her hotel room (not a fixed location) does not disqualify her home office as her principal place of business.
Example #3: Paul is a self-employed anesthesiologist. He spends the majority of his time administering anesthesia and postoperative care in three local hospitals. One of the hospitals provides him with a small shared office where he could conduct administrative or management activities. Paul does not use the office the hospital provides. He uses a room in his home that he has converted to an office. He uses this room exclusively and regularly to prepare his schedule, prepare for treatments and presentations, maintain billing records and patient logs, and read medical journals and books.
Paul's home office qualifies as his principal place of business for deducting expenses for its use. His choice to use his home office instead of one provided by the hospital does not disqualify his home office as his principal place of business. His performance of substantial nonadministrative or nonmanagement activities at fixed locations outside his home also does not disqualify his home office as his principal place of business.
Example #4: Kathleen is employed as a teacher. She is required to teach and meet with students at the school and to grade papers and tests. The school provides her with a small office where she can work on her lesson plans, grade papers and tests, and meet with parents and students. The school does not require her to work at home. Kathleen prefers to use the office she has set up in her home and does not use the one provided by the school. She uses this home office exclusively and regularly for the administrative duties of her teaching job. Because her employer provides her with an office and does not require her to work at home, she does not meet the convenience-of-the-employer test and cannot claim a deduction for the business use of her home.