One phenomenon that will probably emerge as a result of the recession is a growth in home-based businesses. People who’ve been laid off or forced into early retirement may consider this an opportunity to kick-start an enterprise and will often use their home as headquarters. Tools like the personal computer, e-mail and cell phones help make locations less relevant for a wide range of business start-ups.
If you plan to run your small business out of your home, you may be tempted to write off many of your household expenses. But how do you know what is deductible and what is not? The Internal Revenue Service (IRS) has some advice that may help answer the question: “Can I take a Home Office Deduction?”
“Understandably, each of us tries to get as many deductions as possible, but it’s generally wiser to err on the side of caution in this case,” says Mark Snyder, a financial adviser in Medford with several clients who’ve launched home-based businesses. “In order to claim a business deduction, you must use part of your home exclusively and regularly as your principal place of business. Individuals need to be very careful with this deduction as it has very stringent guidelines and has been somewhat of a ‘red-flag’ area with the IRS.”
Generally, expenses related to the rent, purchase, maintenance and repair of a personal residence are not deductible.
“This is complicated because there are a lot of gray areas,” says John Larkin, CPA with Markowitz, Fenelon & Bank, LLP in Southampton. “Many people inquire about it, but they must be able to substantiate it in order to qualify. A business run from one’s kitchen table does not qualify for the deduction. It can be easily abused.”
However, if you legitimately use part of your home for business purposes you may be able to take some home office deductions. Expenses that can be deducted include the business portion of real estate taxes, mortgage interest, rent, utilities, insurance, painting, repairs and depreciation.
“Small business people, like landscapers and contractors with a home office, may be able to take this deduction,” according to Mr. Larkin, who says the number of businesses that can be run from a home office is nearly unlimited. “The rise of e-commerce has made the prospect of working from a home office more reasonable, but it’s important not to be too aggressive when taking this deduction.”
In order to claim a business deduction, you must use part of your home wholly and consistently as your principal business place. If a private tutor is using the den in her home to write lesson plans or review homework and at the same time her family uses the same den for recreation, then a business deduction cannot be claimed for even partial use of the den. The reason is that it is not used exclusively in the tutor’s profession, invalidating any claim for a business deduction. However, small business owners who, on a regular basis, use a portion of their home for storage of business items, such as inventory or product samples, or as a home day care facility may be able to claim a partial deduction.
Requirements for the home office deduction can be found in IRS Publication 587 (www.irs.gov).
Many small business owners must complete Form 8829: Expenses for Business Use of Your Home. It is to be filed with Schedule C. It is recommended that a separate 8829 form be used for each home used for business during the year.
“This deduction has more ramifications than people realize,” says Brian Ferretti, an accountant in Riverhead. “People are often surprised to learn this is hard to recover when they go to sell their home because of the depreciation they may be taking. It becomes a nightmare of a calculation.”
Mr. Ferretti estimates that some 90 percent of those who inquire about taking the home office deduction decide against doing so after learning the requirements.
You can deduct the cost of insurance that covers the business part of your home, but only for the portion that covers you for the tax year in which you are filing. You can deduct the business percentage of the part that applies to the following year in that year.
If you rent the home you occupy and meet the business requirements use of it, you can deduct part of the rent payments. To figure the deduction, multiply the rent payments by the percentage of your home used for business. If you own the home you cannot deduct the fair rental value of your home but instead must calculate for depreciation. Homeowners qualifying to deduct expense for business use can claim a depreciation deduction. This is an allowance for wear and tear on the part of the home used for business.
If you work as an employee, you can claim this deduction only if the regular and exclusive business use of the home is for the convenience of your employer and the portion of the home is not rented by the employer.
In the eyes of the IRS, “exclusive use” means a specific area of the home is used solely for trade or business. “Regular use” means the area is used regularly for trade or business. “Incidental or occasional” business use is not considered regular use. Similarly, non-business profit-seeking endeavors such as investment activities do not qualify for a home office deduction, nor do not-for-profit activities such as hobbies or fund-raising efforts.
When it comes to taxes, write-offs can be misleading and confusing in addition to tempting. Some go overboard and aim to deduct everything they possibly can. These are the types most likely to get letters from the IRS after they’ve submitted their tax returns asking for further explanations.
When tax season comes around there’s nothing like a good deduction. But before deciding to claim a home office deduction, thoroughly speak with a tax professional to determine if such an action makes long-term financial success for you.
Joseph Finora Jr.
is a freelance writer who lives in Laurel. Contact him at firstname.lastname@example.org.