Question or Topic 

The Question:  What are the qualifications to take the home office deductions:

Objectives

Lear what the qualification rules are and what is deductible

Related Articles

1. Letter to my clients

   1. Home Office Intro

2. Decision Chart  

3. Home Office Rules  

4. Tax Killers Focus

   1. Home Office Update

   2. Home Office Rules

5. Forms & Checklists

   1. What I need for Home Office deductions

   2. Finding the Costs

6. Spreadsheets, etc.

   1. Step 1 in your defense

   2. Home Office Logbook

7. Home Office

   1. Home Office

   2. Home Office Deduction

   3. Home Office Expense

   4. Home Office Rules

   5. Home Office - Tax Computations

The Answer

Introduction

      2 Types of Employment Are Looked At In This Article

1.      Self-employed

2.      Employee

In Addition, The Following, Exceptions Are Covered

      Separate Structure Exception

      Inventory Storage Exception

Starting with the 1999 return, you can write off expenses for your home office if you're self employed, it's your only office, and you use the space "exclusively and regularly" (that's IRS lingo) for "substantial administrative or management" tasks related to your work.

Believe it or not, this is an improvement: Previously, you could only   claim your home office if you performed your most important money-making duties there (a doctor would have to see her patients there, for  example--paperwork alone wouldn't cut it). If you decide to take this  deduction, it's important that you meticulously document use of the
office.

General Comments:  The tax laws for claiming a deduction for business use of your home are complicated.  Many people operating businesses have offices in their homes for scheduling appointments, paying bills, and keeping business records. Depending on your circumstances, expenses related to your home office may be deductible.

Your home office may be in any type of residence such as a house, apartment, condominium, mobile home, or boat. You do not need to own your home in order to claim an "office in the home" deduction. A garage or storage area can be considered when determining whether you qualify for the deduction.

Qualifying For A Deduction

Your use of the business part of your home must be:

• Exclusive
• Regular
• For your trade or business, AND

The business part of your home must be one of the following:

• Your principal place of business
• A place where you meet or deal with customers in the normal course of your trade or business, OR
• A separate structure you use in connection with your trade or business

Business Use of Home

Whether you are self–employed or are an employee, you may be able to deduct certain expenses for a part of your home you use for business.

To deduct business–use–of–the–home expenses, a part of your home must be used regularly and exclusively:

·  As the principal place of business for trade or business,

·  As the place where you meet and deal with your patients, clients, or customers in the normal course of your trade or business; or

·  In connection with your trade or business, if you use a separate structure that is not attached to your home.

If you use both your home and other locations regularly in the same trade or business, you must determine which location is your principal place of business.

Your home office will also qualify as your principal place of business for deducting expenses for its use if you meet the following requirements:

·  You use it exclusively and regularly for administrative or management activities of your trade or business, and

·  You have no other fixed location where you conduct substantial administrative or management activities of your trade or business.

In general, because of the exclusive–use rule, you cannot deduct business expenses for any part of your home that you use for both personal and business purposes. For example, if you are an attorney and use the den of your home to write legal briefs and also for personal purposes, you may not deduct any business–use–of–your–home expenses. The only exceptions to the exclusive–business–use rule are for qualified day–care providers, and for persons storing inventory or product samples used in their business.

If you are an employee, additional rules apply. Even if you meet the exclusive and regular use tests, you cannot take any deductions for the business use of your home unless:

·  this use of your home is for the convenience of your employer, and

·  you do not rent all or part of your home to your employer and use the rented part to perform services as an employee.

If your gross income from the business use of your home is less than your total business expenses, your deduction for certain expenses for the business use of your home is limited. However, those business expenses that are not deducted because of the limit can be carried forward as part of next year's business–use–of–the–home expenses.

1. Exclusive Use

2. Regular Use

3. Business Use

4. Principal Place of Business, or Where One Meets Customers

Exclusive Use:  To qualify for this test, you must have a specific area of your home used only for the business.  The area used can be a room or other space identified as separate, but the area must be used solely for business.  For example, if you have a room set up as an office, but occasionally use it also as a guest room, you do not meet this test.  Likewise, if the area is used to handle personal finances or homework, you do not meet this test. In order to meet this test, you must use the area solely for the business.

Exceptions to Exclusive Use

You do not have to meet the exclusive use test if either of the following applies.

1 You use part of your home for the storage of inventory or product samples.

2 You use part of your home as a day-care facility.

Regular Use:  In order to meet this test, you must use the specific area on a continuing basis. If it is used only occasionally, you don't meet this test.  However, if, it is typical to have a slow period during seasonally, as long as the area is still set aside and not used for any other purpose, the slow down of the business would not prevent you from meeting this test.

 Regular Use --- To qualify under the regular use test, you must use a specific area of your home for business on a continuing basis. You do not meet the test if your business use of the area is only occasional or incidental, even if you do not use that area for any other purpose.

Business Use:  If you are actively operating your business, you will meet this test.

This describes how the business must use the business portion of your home---

Trade or Business Use:  To qualify under the trade or business use test, you must use part of your home in connection with a trade or business. If you use your home for a profit-seeking activity that is not a trade or business, you cannot take a deduction for its business use.

Place of Business

The fourth test requires that your home office is either your principal place of business or the place you regularly meet with customers.

The Business Portion Must Be One Of The Following

a) Your principal place of business (defined later),

b) A place where you meet or deal with patients, clients, or customers in the normal course of your trade or business, or

c) A separate structure (not attached to your home) you use in connection with your trade or business.  

Principal Place of Business

To meet this test, your home office must be your principal place of business.  As long as you use the area exclusively and regularly for the administrative or management activities of your business, and you have no other fixed location where you conduct these activities on a substantial basis, your office will qualify.

Before 1999, the only definition of Principal Place of Business was the place where:

• you conducted the most important activities for that business, and
• you spent the most time.

While, a construction site, a hospital or clinic, the point of contact for outside sales, etc., do met these tests, a home office does not.  The text describes a new, alternative definition.

 Principal Place of Business

You can have more than one business location, including your home, for a single trade or business. To qualify to deduct the expenses for the business use of your home under the principal place of business test, your home must be your principal place of business for that trade or business. To determine your principal place of business, you must consider all the facts and circumstances.  Your home office will qualify as your principal place of business for deducting expenses for its use if you meet the following requirements.

1. You use it exclusively and regularly for administrative or management activities of your trade or business.

2. You have no other fixed location where you conduct substantial administrative or management activities of your trade or business.  Alternatively, if you use your home exclusively and regularly for your business, but your home office does not qualify as your principal place of business based on the previous rules, you determine your principal place of business based on the following factors.

1. The relative importance of the activities performed at each location.

2. If the relative importance factor does not determine your principal place of business, you can also consider the time spent at each location. If, after considering your business locations, your home cannot be identified as your principal place of business, you cannot deduct home office expenses. However, see the later discussions under Place To Meet Patients, Clients, or Customers or Separate Structure for other ways to qualify to deduct home office expenses.

Administrative or management activities. There are many activities that are administrative or managerial in nature. The following are a few examples.

1. Billing customers, clients, or patients.

2. Keeping books and records.

3. Ordering supplies.

4. Setting up appointments.

Forwarding orders or writing reports.

Administrative or management activities performed at other locations. The following activities performed by you or others will not disqualify your home office from  being your principal place of business.

1. You have others conduct your administrative or management activities at locations other than your home. (For example, another company does your billing from its place of business.)

2. You conduct administrative or management activities at places that are not fixed locations of your busisuch ness, such as in a car or a hotel room.

3. You occasionally conduct minimal administrative or management activities at a fixed location outside your home.

4. You conduct substantial nonadministrative or nonhome management business activities at a fixed location outside your home. (For example, you meet with or provide services to customers, clients, or patients at a fixed location of the business outside your home.)   

5. You have suitable space to conduct administrative or management activities outside your home, but choose to use your home office for those activities instead.  

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 activities of his business, busisuch as phoning customers, ordering supplies, and keeping his books.  John does not do his own billing. He 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. He uses the nonhome office for the administrative or managerial activities of his plumbing business and he has no other fixed location where he conducts these administrative or managerial activities. His choice to have his billing done by another  company does not disqualify his home office from being his principal place of business. Because he meets all the qualifications, including principal place of business, he can

deduct expenses (to the extent of the deduction limit,explained later) for the business use of his home.

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 business is selling products to customers at various locations throughout her territory. To make these sales, she regularly visits customers to explain the availbusiness able products and take orders. Pamela’s home office qualifies as her principal place of business for deducting expenses for its use. She conducts administrative or management activities there and she has no other fixed location where she conducts administrative or management activities. The fact that she conducts some administrative or management activities in her hotel room

(not a fixed location) does not disqualify her home office from being her principal place of business. Because she meets all the qualifications, including principal place of business, she can deduct expenses (to the extent of the deduction limit, explained later) for the business use of her home.

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 conduct all the following activities.

1 Contacting patients, surgeons, and hospitals regarding scheduling.

2 Preparing for treatments and presentations.

3 Maintaining billing records and patient logs.

4 Satisfying continuing medical education requirements.

5 Reading medical journals and books.

Paul’s home office qualifies as his principal place of business for deducting expenses for its use. He conducts administrative or management activities for his business as an anesthesiologist there and he has no other fixed location where he conducts administrative or management activities for this business. His choice to use his home office instead of one provided by the hospital does not disqualify his home office from being his principal place of business. His performance of substantial nonadministra- customtive or nonmanagement activities at fixed locations outside his home also does not disqualify his home office from being his principal place of business. Because he meets all the qualifications, including principal place of business, he can deduct expenses (to the extent of the deduction limit, explained later) for the business use of his home.

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.  Kathleen must meet the convenience-of-the-employer test, even if her home qualifies as her principal place of availbusiness for deducting expenses for its use. 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.

More Than One Trade or Business

Whether your home office is the principal place of business must be determined separately for each trade or business activity. One home office may be the principal place of business for more than one activity. However, you will not meet the exclusive use test for any activity unless each activity conducted in that office meets all the tests for the business use of the home deduction.  

Example. Tracy White is employed as a teacher. Her principal place of work is the school. She also has a mail order jewelry business. All her work in the jewelry business is done in her home office and the office is used exclusively for that business. If she meets all the other tests, she can deduct expenses for business use of her home for the jewelry business.

If Tracy also uses the office for work related to her teaching, she would not meet the exclusive use test for the jewelry business. As an employee, Tracy must meet the convenience-of-the-employer test to qualify for the deduction. Because she does not meet this test for her work as a teacher, she cannot claim a deduction for the business use requireof her home for either activity.

Place To Meet Patients, Clients, or Customers

If you meet or deal with patients, clients, or customers in your home in the normal course of your business, even though you also carry on business at another location, you can deduct your expenses for the part of your home used exclusively and regularly for business if you meet the following tests.

1 You physically meet with patients, clients, or customers on your premises.

2 Their use of your home is substantial and integral to the conduct of your business.

 Doctors, dentists, attorneys, and other professionals who maintain offices in their homes will generally meet this requirement.  Using your home for occasional meetings and telephone calls will not qualify you to deduct expenses for the business use of your home.  The part of your home you use exclusively and regularly

to meet patients, clients, or customers does not have to be your principal place of business. 

Example. June Quill, a self-employed attorney, works 3 days a week in her city office. She works 2 days a week in her home office used only for business. She regularly meets clients there. Her home office qualifies for a business deduction because she meets clients there in the normal course of her business.  

Self-employed

If you receive the following form:

You are self-employed

The self-employed will take the deduction on Schedule C.

For The Self Employed-

You Must Meet  Tests

1.                  Exclusive Use

2.                  Regular Use

3.                  Business Use

4.                  Principal Place of Business, or Where One Meets Customers

Employees

If You Receive The Following Form:

You are an employee

The Employee Must Meet  Tests

 PLUS a  Test

1. Exclusive Use
2. Regular Use
3. Business Use
4. Principal Place of Business, or Where One Meets Customers
5. Must Be For The Convenience of the Employer (See Exceptions Inventory and Separate Structure) AND You do not rent any part of your home to your employer and use the rented portion to perform services as an employee. Whether the business use of your home is for your employer’s convenience depends on all the facts and circumstances.

Home office deduction for employees . . . While the rules have been eased for self-employed individuals who use a portion of their residence for a home office, they have not changed with respect to employees who use their home for business.

In the case of an employee, the home office deduction is allowable only if, in addition to satisfying the exclusive and regular use test, the home office is for the convenience of the employer.

The rule is, the home office must be for the convenience of the employer.  It cannot be just appropriate or helpful to your business.  Getting a letter from your boss may not mean much.  For example, you are required to do paperwork after hours, but your office closes at 5 and is closed on weekends.  You may be able to take a home office deduction.  On the other hand, assume the office is open until midnight and on weekends, but getting home after 7 would add two hours to your trip because the trains do not run as often.  Too bad.  Having an office at home would be for your convenience, not your employer's.  The facts are critical. Best advice, check with a Bob Parrish CPA, P.C. and/or furnish all the needed information to prepare the home office expense and let Bob Parrish make the determination for you.

In the case of an employee, the home office deduction is allowable only if, in addition to satisfying the exclusive and regular use test, the home office is for the convenience of the employer.  Furthermore, expenses allocable to the use of a portion of a residence on a regular basis as a storage unit for the taxpayer's inventory or product samples will be allowed as a deduction if the taxpayer is engaged in the trade or business of selling products at retail or wholesale, but only if the residence is the sole fixed location of that business.

Even if you meet the exclusive and regular use tests, you cannot take any deductions for the business use of your home unless:

·  this use of your home is for the convenience of your employer, and

·  you do not rent all or part of your home to your employer and use the rented part to perform services as an employee.

The employee will take the deduction as an Itemized Deduction on Schedule A.

Separate Structures

If you have a separate structure and you use it exclusively and regularly for your business, you may deduct the expenses related to the structure whether or not you can deduct your home office expenses.  These expenses could include:

• Utilities
• Depreciation allowed on the furnishings
• Depreciation allowed on the structure
• Repairs  

You can deduct expenses for a separate free-standing structure, such as a studio, garage, or barn, if you use it exclusively and regularly for your business. The structure does not have to be your principal place of business or a place where you meet patients, clients, or customers.  

Examples:

1. John Berry operates a floral shop in town. He grows the plants for his shop in a greenhouse behind his home. Since he uses the greenhouse exclusively and regularly in his business, he can deduct the expenses for its use, subject to the deduction limit, explained later.

2. Ben is a self-employed painter. He rents office space where his bookkeeper works and he meets with contractors. He also has a storage shed in his backyard which he uses only to store the tools and supplies used in his business. Although Ben does not have a home office, he can still deduct the direct expenses related to the shed.  

3. Adam is a self-employed roofer.  He has a home office where he kept his books. Adam also has a storage shed in his backyard which he uses only to store the tools used in the business. Adam can deduct the expenses directly related to the storage shed and the expenses for his home office.

Inventory:  In addition, expenses allocable to the use of a portion of a residence on a regular basis as a storage unit for the taxpayer's inventory or product samples will be allowed as a deduction if the taxpayer is engaged in the trade or business of selling products at retail or wholesale, but only if the residence is the sole fixed location of that business.  

Storage of inventory or product samples. If you use part of your home for the storage of inventory or product samples, you can claim expenses for the business use of your home without meeting the exclusive use test.  However, you must meet all of the following tests.

1. You sell products at wholesale or retail as your trade or business.

2. You keep the inventory or product samples in your home for use in your trade or business.

3. Your home is the only fixed location of your trade or business.

4. You use the storage space on a regular basis.

5. The space you use is an identifiably separate space suitable for storage.

Example. Your home is the sole fixed location of your business of selling mechanics’ tools at retail. You regularly

use half of your basement for storage of inventory and product samples. You sometimes use the area for personal purposes. The expenses for the storage space are deductible even though you do not use this part of your basement exclusively for business.  

Figuring the Deduction

If you have met the requirements for a qualified home office, you can figure the deduction. You will need to consider the costs of taking care of your home and the cost of taking care of your office. For all of the expenses, you must maintain adequate records to support the deduction.

Expenses Always Deductible

Some expenses can be deducted even if you do not have a qualified home office. These costs should be deducted as normal business expenses and not included in the home office deduction. These expenses include:

• office supplies
• office wages
• separate business telephone line
• depreciation on office equipment & furniture (with limitations)

Expenses Never Deductible

Some expenses can't be deducted even if you have a qualified home office. These costs are always considered personal, and can't be deducted. They include:

• The first telephone line into the house
• Maintenance of your yard
• Repairs & maintenance to areas of your home not related to the office

Expenses Partially Deductible

Some expenses of maintaining your home will be partially deductible when you have a qualified home office. These expenses include:

• Mortgage Interest
• Real Estate Taxes
• Homeowners insurance
• Rent expense
• Utilities
• Monitoring of a security system
• General repairs to the home (i.e. furnace repair)  - painting, miscellaneous repairs, etc.

Note: The personal portions of Mortgage Interest and Real Estate Taxes are deductible on Schedule A, Itemized Deductions.

Business Percentage

The amount deductible is dependant upon the percentage of the home used for business.  For each of the Partially Deductible items, you must determine the Business Use Percentage of your home.  You can use either the Square Footage Method or, if the rooms in your house are all about the same size, the Room Count Method.

If your gross income from the business use of your home is less than your total business expenses, your deduction for certain expenses for the business use of your home is limited. However, those business expenses that are not deducted because of the limit can be carried forward as part of next year's business–use–of–the–home expenses.

Square Footage Method

Office Square Footage
----------------------------------------- = Business Percentage
Total Home Square Footage

Room Count Method

Office Room(s)
-------------------------------- = Business Percentage
Total Rooms in Home

The following table summarizes the typical expenses.

Depreciating Your Home

You can claim depreciation on office furniture and equipment even if you do not have a qualified home office.  If you have a qualified home office, you can deduct depreciation on your home.

To figure the deduction on your home, you need to know:

• The month and year you started using your home for business
• The adjusted basis and fair market value of your home at the time you began using it for business
• The cost of any improvements before and after you began using the property for business
• The percentage of your home used for business

NOTE: If you claim depreciation for your home office, you may have a taxable gain when you sell your home.  The gain on the sale of the home may be both personal and business. The personal portion of the gain may be partly or completely excluded from income.  However, the business portion of the gain will be taxable and will include the amount of depreciation claimed in the past.

Record keeping:  You do not have to use a particular method of record keeping, but you must keep records that provide the information needed to figure your deductions for the business use of your home.  You should keep canceled checks, receipts, paid bills and other evidence of expenses you paid.

Your records must show the following information:

1. The part of your home you use for business.

2. That you use part of your home exclusively and regularly for business as either your principal place of business or as the place where you meet or deal with clients or customers in the normal course of your business.  (However, see the earlier discussion, Exceptions to Exclusive Use.)

3. The depreciation and expenses for the business part.

You must keep your records for as long as they are important for any tax law.  This is usually the later of the following dates.

1. 3 years from the return due date or the date filed.

2. 2 years from the date the tax was paid.

Keep records to prove your home’s depreciable basis.  This includes records of when and how you acquired your home, your original purchase price, any improvements to your home, and any depreciation you are allowed because you maintained an office in your home.  You can keep copies of the depreciation worksheets and the tax return as a part of your records.

 Bob Parrish CPA, P.C.  

Solutions

Solutions are dependent upon facts & circumstances, law and the objectives.  These elements vary from one time to another, from one circumstance to another and from person or entity to another.

Kit to Prepare for Your Adviser

1040 Home Office Deduction Organizer

1040 Home Improvements Organizer

Do It Yourself

Tools

Amortization

Property Basis New Equipment Purchase

Decision Chart  

Home Office Logbook

Sample Documents

None

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