This article is by CRS instructor, Chris Byrd who is well known for his tax strategy seminars. He has been a speaker for the Northern CA CRS Chapter and we find him to be very good! Chris@ChrisBirdSeminars.com or http://www/.chrisbirdseminars.com
Qualifying for the Home Office Deduction
The deduction allows you to deduct a pro-rata portion of your residential costs as a business expense when it's used as your principal place of business. The percentage of allowable expense (found by dividing the square footage of the office by the home's total square footage) can be applied to mortgage interest, insurance, property tax, rent, depreciation, utilities, and other home-related expenses.
The two requirements:
1. The space is exclusively used for business
2. You must regularly conduct some kind of business activity in the space
The home office deduction can only be taken if a portion of the home is used "exclusively and primarily" for business. That means the designated space cannot be used for any other purpose, like a guest room.
Although the space must be "separately identifiable," it needn't be blocked off with a permanent partition. This deduction can also apply to a separate structure not attached to the dwelling unit.
Your Home Office Needs to be Your Principal Place of Business
More taxpayers qualify since the definition of "principal place of business" was broadened to include a place where administrative or management activities are conducted on a substantial basis, if there is no other fixed location where they conduct substantial administrative or management activities (Taxpayer Relief Act of 1997). In short, this means that a self-employed person needs to spend more time running their business from home, not the brokerage sales office.
In my experience, real estate agents often fail to qualify for this deduction because they already have a brokerage sales office, where most of their activities in running their business are conducted.
Also, if you are an employee who works at home, the rules state that the home office must be for your employer's convenience, rather than your own. As popular as tele-commuting has become, make sure this point is clarified with your employer. That way you can document that the office space is specifically required by them.
One caveat for anyone taking this deduction. It cannot be taken for any year when the amount claimed will generate a net loss for the business. However, the untaken deduction can be carried forward to a year when there is sufficient profit to avoid that limitation.
Selling a Residence with a Home Office
In December, 2002, the US Treasury approved a change that removed a major negative for those who'd been taking the home office deduction. (And for those who feared taking it.) Normally, gain on the sale of a principal residence (where you resided two or more years) is tax free. Until that change, homeowners who sold would owe tax on the gain allocated to the office portion of their home.
The new Treasury rules change mean that a seller must no longer allocate the amount of gain between their business and personal use. The home office had to be within the house, however. And the new rules don't excuse any depreciation recapture that may have been taken for the home office.
Make Your House "Pay its Way"
Whether taking the home office deduction is tax-wise depends on your circumstances. Study the details in IRS Publication 587 http://www.irs.gov/publications/p587/Here's a tax strategy that every self-employed person should reconsider. Especially since several of the "traps" regarding the home-office deduction have been dismantled. Its tax advantages are substantial and could bring you significant savings-year after year
As always, please always consult withe your CPA or tax person regarding tax advice!