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Have a Home Office?
Andrea Bonaccorsi, CPA
Manager, Tax Services
September 8, 2009
Home may be where the heart is, but for a growing number of Americans it's also the center of business activity.
For home-based business owners, full-time and part-time telecommuters, and busy executives putting in a few extra hours at home, technological advances and a changing financial climate have made work outside of a traditional office environment practical.
If you operate a business from home―or are an employee working from home for the convenience of your employer―you may qualify for a home office deduction on your federal income tax return. For this purpose, you don't have to actually own a house. The IRS defines a home as a "house, apartment, condominium, mobile home, boat, or similar property which provides basic living accommodations. It also includes structures on the property, such as an unattached garage, studio, barn or greenhouse."
Perhaps surprisingly, only 46 percent of eligible home-based businesses actually take a home office deduction, according to a recent survey by the National Federation of Independent Business. The main reason: confusion and perceived complexity. To ensure that you benefit from all of the tax deductions available to you, it's important to have a basic understanding of the rules.
Qualifying for a Home Office Deduction
As a general rule, you can claim a deduction for the business use of your home if you use a part of the home exclusively and regularly in one or more of the ways listed below.
 Your home office is your principal place of business.
You use your home office as a place to meet customers, clients, or patients in the normal course of business.
If your home office is a separate structure that is not attached to your home, you use it in connection with your trade or business
The portion of your home used for business can be a room or other separately identifiable space; it does not require a permanent partition to qualify.
If you are an employee, the exclusive and regular use of your home must be for the convenience of your employer. Additionally you won't qualify for a deduction if you rent a portion of your home to your employer and then use that portion of your home to perform work for your employer.
You may also qualify for a home office deduction if you use a portion of your home to store inventory or product samples, or as a daycare facility. In this case, you must use your home regularly for this purpose, but your use doesn't have to be exclusive.
Calculating the Amount of the Deduction
If you qualify for the home office deduction, the total amount of your deduction includes a combination of expenditures that are fully deductible and others that are prorated based on the percentage of your home that is used for business.
Fully Deductible Expenditures
You can deduct the total amount of those business expenses that stem exclusively from the business use of your home, including such things as business insurance, repairs to the business portion of the house, and a separate phone line used exclusively for your business:
Partially Deductible Expenditures
You can also deduct the business portion of expenses related to your entire home, such as insurance, utilities, real estate taxes, a security system, mortgage interest, and depreciation. The portion of these expenses eligible for the home office deduction is determined based on the percentage of your home that you use for business.
To calculate the percentage of your home used for business, divide the area (length x width) of the portion you use for business by the total area of your home. Alternatively, if your rooms are similar in size, you can divide the number of rooms you use for business by the total number of rooms.
Limitation
Your deductible expenses are limited to the gross income generated by the business. In other words, the total amount of your business expenses plus depreciation cannot exceed the gross income from the business use of your home, or your ability to deduct certain expenses will be limited.
If your deductions exceed the limit in the current tax year, you can carry the excess deductions over to the next tax year.
If You Sell Your Home
Under the federal tax rules, you can exclude up to $250,000 of the gain from the sale of your personal residence ($500,000 for married couples) if you satisfy certain ownership and use tests. If you used a portion of your home for business, however, you may not be able to exclude all of the gain.
If the business portion of your home is located within your home and not in a separate structure, you cannot exclude a portion of the gain equal to the depreciation you deducted (or were allowed to deduct) after May 6, 1997.
If the business portion of your home is located in a separate structure on the property, and you did not occupy that structure as your personal residence for two of the last five years, you must allocate the gain. The portion of the sales proceeds that can be attributed to the business structure are taxable.
For More Information
To learn more about the federal income tax rules for a home office deduction, you can refer to IRS Publication 587 Business Use of Your Home, available online at http://www.irs.gov/pub/irs-pdf/p587.pdf.
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