Taxing Times ... The Home Office Deduction

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by Elena Fawkner

Yay! It's tax time again (or near enough). I can't wait. Just love this stuff. Not! OK, I know it's boring, I know your eyes glaze over at the mere thought of all those forms and paperwork but it has to be done so let's just bite the bullet and get on with it.

Now let's start with the fact that there's no substitute for a qualified professional when it comes to this sort of stuff, so I'm not going to attempt a comprehensive survey of everything you need to think about when it comes to tax and your home business. What we're going to look at in this article is *one aspect* of home business taxation in the U.S.: the home office deduction. Having a working knowledge of this deduction BEFORE you hand everything over to your accountant will not only save both of you a lot of time (and therefore expense), but also ensure that you keep good records of everything you need to. Although this article focuses on U.S. tax law, many other countries have enacted similar laws. So if you're outside the U.S., check with your local tax office to see what comparable deductions may be available in your country. I know, for example, that the Australian home office deduction is very similar.

I figured a good place to start researching this article was the IRS itself. Clever, no? There's a pretty handy flowchart at the IRS site that sets out quite clearly the elements you need to satisfy in order to deduct the business use of home expenses, so we'll just follow that. If you're interested in checking it out for yourself, it's at http://www.irs.gov/forms_pubs/graphics/15154t01.gif.

What Is a Home?

For the purposes of the home business deduction, a "home" means a house, apartment, condo, mobile home or boat as well as other structures on the property such as a garage, shed or barn. It does not include property used exclusively as a hotel or an inn.

Is Part of Your Home Used in Connection with a Trade or Business?

If not, you can't deduct business use of home expenses. Duh. Stop reading now.

In order to satisfy the trade or business use test, you must use part of your home in connection with a trade or business. So far so good. But if you use your home for a profit-seeking activity that is not trade or business, you cannot claim a deduction for the business use of home expenses. A good example given by the IRS is research you undertake for your own private stockmarket investments. Although this is a profit-seeking activity, you are not involved in the trade or business of stockbroking or dealing and so you cannot claim the home business deduction.

Is the Use Regular and Exclusive?

OK, this is where things get a little trickier.

The Exclusive Use Test:

To qualify under the exclusive use test, a specific area of your home must be used solely for your trade or business. It can be a separate room or part of a room but it need not be marked off by any form of permanent partition.

So, if you have an "L" shape living room/dining room area and the dining room area is hived off as your "office" and is used for no other purpose, then this satisfies the exclusive use test.

If, however, you clear the dining table of your papers every night so the family can use it for dinner, you don't meet the exclusive use test. So confine family meals to the kitchen! Easy.

Exceptions to the Exclusive Use Test:

The only exceptions to the exclusive use test are if you use part of your home for the storage of inventory or product samples or as a day-care facility.

If you use part of your home for storage of inventory or product samples, although you don't have to satisfy the exclusive use test, you must meet all of the following tests instead:

herefore, if you store your inventory of knitting wool for your Internet business of selling wool, knitting patterns and knitting needles in your basement, then you will still be able to deduct your basement expenses (or part of your basement expenses) even though your basement is also used as a recreation or workshop area.

The Regular Use Test:

In addition to satisfying the exclusive use test, you must also satisfy the regular use test.

This means that you must use the specific area of your home you use exclusively for business purposes on a continuing basis. This means more than occasional or incidental use.

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