An estimated 30 million U.S. taxpayers work full or part time from their owned or rented residences. Whether self-employed or working at home for the convenience of your employer, you may be entitled to significant tax-saving deductions for part of your household expenses.
* Home-based employees, such as a salesperson or a computer programmer working from home, have a special test to pass before being allowed to deduct home-business expenses.
The work at home must be for the “convenience of the employer,” which means your employer doesn’t provide suitable work space and expects you to work primarily from your residence. However, if you rent part of your residence to your employer at a fixed rent, you won’t qualify. If you are an employee who just prefers working from home, you don’t meet the “convenience of the employer” test.
* The primary home-business location test for full-time or part-time self-employed business owners requires that their residences are either (1) used to meet or deal with patients, clients or customers, or (2) if they have no other fixed business location, the residence is the principal business location used for administrative activity.
* An “exclusive home-business area” is required. It need not be a full room but can be part of a room, such as where you have your business equipment and supplies. However, it cannot be shared use. Using your dining room table to do your bookkeeping clearly won’t qualify if you also have family meals there.
* Even a part-time business use can qualify. The leading U.S. Tax Court decision in Dr. Edwin Curphey (73 T.C. 61) shows how a full-time employee can also deduct home-business expenses for a part-time business. Curphey, a full-time dermatologist at a hospital, managed his rental properties part time from his home office. Because he had an exclusive home-business area, his home office met the residence-business deduction test.
The area used for storage of inventory or business equipment can also qualify. For example, if you are a part-time Amway or Avon salesperson using part of your garage to store inventory and supplies, that exclusive business area meets the test.
However, part-time home use for occasional investing won’t qualify. In the Joseph Moller case (553 Fed.2d 1071), Moller earned 98% of his income by investing in stocks and bonds from his residence. But the U.S. Court of Appeals denied his home-business deductions because he was a passive, long-term investor rather than an active “day trader” with many transactions.
* Home-business area square footage determines your deductions, whether you’re self-employed or a qualified “convenience of the employer” employee. IRS Form 8829 (Expenses for Business Use of Your Home) is the place to calculate square footage and the percent of home-business deductions. For example, suppose you own an 1,800-square-foot house. Your exclusive business area is 600 square feet. The result is 33% of your household costs -- homeowners insurance, utilities, repairs, mortgage interest and property taxes -- become deductible.
However, 100% of some home-business costs are deductible. For example, business phone expenses are fully deductible. All the cost of painting or renovating the business area is deductible. Your business insurance premiums also would be fully tax-deductible.
* Claim business depreciation if you own your residence. Homeowners and condo owners who use part of their residence for qualified business use can claim depreciation for the area used exclusively for business. Using the above example, where the business occupies 33% of the residence, you can depreciate 33% of your home’s purchase price (excluding land value) on the 39-year commercial property straight-line depreciation schedule. However, when you sell at a profit, the special 25% federal tax rate applies to your recaptured depreciation deductions. But IRS regulation 2002-142 says that when you sell your principal residence, even its “business area” can qualify for the $250,000/$500,000 tax exemption of Internal Revenue Code 121.
* Generous new home-business equipment deductions. Effective with the 2003 tax year, home-business owners can deduct up to $100,000 for business equipment purchases. The result: There is no need to depreciate equipment expenses that cost less than $100,000 total, even if the purchase was completed Dec. 31, 2003. However, if the annual total business equipment purchases were greater than $100,000, the excess must be depreciated over the equipment’s depreciable life.
* Business auto expenses start at your door. If you begin your business day at your home office, your automobile or truck expenses are tax-deductible after you leave your home office. If you keep a record of business-trip mileage, the IRS allows 36 cents per business mile for 2003.
* Watch out for home-business deduction limits. If your deductions exceed the home-business income, the excess cannot be used to create a tax loss to shelter other income, such as interest and dividends. To illustrate, suppose the part-time home business had $10,000 net income before the IRS Form 8829 home-business use deductions, which total $15,000. In this example, you can deduct only $10,000 of home-office expenses, but the remaining $5,000 can be carried to a future tax year.
Next week: Realty investors enjoy special tax breaks.