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Home-office deductions just got
easier
By Cora M. Barnhart and Luis I. Ingles
III, CPA • Bankrate.com
May 27, 1999 -- Are you a small business owner
who tends to work at home? New rules in effect for 1999 have improved
your chances of qualifying for the home-office deduction. More taxpayers
than ever can deduct the business use of their home this year, even
if they haven't qualified for this deduction in the past. The deduction
is available to self-employed people as well as those who work for
others.
This tax tip discusses the standards your office
must meet to qualify for this deduction. Eligibility relies on whether
the area in question has exclusive and regular business use, is
the principal location of business, and is a meeting location for
professional contacts. This tax tip also clarifies the deductibility
requirements for unattached structures.
Exclusive and regular
business use is a requirement
The first requirement is that the area used for business must
be used exclusively and regularly for at least one of the following
purposes:
- As the principal place of business for any
trade or business
- As a place to meet or deal with clients in
the normal course of the business
- In connection with the business, if it is
a separate structure unattached to the taxpayer's personal residence
The definitions of "exclusively"
and "regularly" are critical:
- "Exclusively" means for business
purposes only. Using part of a home as a business office and also
for personal purposes doesn't qualify as exclusive. Two exceptions
to this rule are storage of inventory and day-care facilities.
- "Regularly" means on a continuing
basis. A part of a home used only occasionally or incidentally
doesn't qualify, even if that part of the home isn't used for
any personal or other purpose.
Test 1: Principal place
of business
There has been a change in interpretation in this portion of
the tax code. For tax years 1998 and before, what determined the
principal place of business was the relative importance of
the activities performed at each business location. If the business
activities outside the home were more important than the business
activities performed in the home, the home didn't qualify as a principal
place of business.
What determined the importance of activities?
The nature of the business. For example, if the business was a retail
company selling goods to the general public, the most important
activity occurred at the location where the owner met his customers.
Necessary activities such as accounting or billing weren't deemed
the most important aspects of this business.
With the new rules in place for tax years 1999
and later, the IRS will consider the home office in the example
above as the principal place of business if:
- It is used exclusively and regularly for
administrative or management activities of trade or business,
and
- There isn't another fixed location for these
administrative or management activities.
Yet the new rules regarding the principal place
of business haven't eliminated other hurdles your office must clear
to pass the first test. Besides meeting the "exclusively"
and "regularly" components of the rule, your home office
also must meet three other requirements:
- Trade or business use -- If you intend to
claim a portion of your home as a home office, keep in mind that
it must be used in connection with your trade or business. You
can't use it for an unrelated profit-seeking activity and deduct
expenses for its use.
- Convenience of the employer -- If you are
an employee and want to deduct your home office, you must pass
the convenience of the employer test. If your employer provides
an office for you, you can't deduct your office unless you are
required to work at home.
- Deduction limit -- Even if your home office
qualifies for this deduction, the amount may be limited if expenses
from your home office exceed gross income earned from your home
office. Consult IRS Publication 587 for the rules on the deduction
limit.
Test 2: Is it a place
to meet patients, clients, or customers?
Do you meet or deal with patients, clients or customers in your
home in the normal course of business? You can deduct expenses for
the part of your home used exclusively and regularly for business.
The deduction is still legitimate if you also carry on the business
at another location and the home isn't the principal place of business.
Suppose an attorney works four days a week in
a downtown office and one day a week in a home office used exclusively
for meeting with clients. Since the use of the home is regular and
integral to the conduct of the business, the home office qualifies
for a business deduction.
Test 3: Separate structures
are deductible
If you use a freestanding structure separate from your home, such
as a studio, garage or barn, you can deduct the expenses for this
structure if it is used exclusively and regularly for business.
Again, this structure doesn't need to be the principal place of
business. You aren't required to use it to meet patients, clients,
or customers.
An example of this would be a florist who grows
plants for her shop in a greenhouse behind her personal residence.
The floral shop is the principal place of business and is at a different
location. However, the florist can still deduct expenses for the
greenhouse since she uses it exclusively and regularly in her business.
Conclusion
One of the most well-publicized tax changes for 1999 is the home-office
deduction. Recent changes in tax legislation benefit many small
business owners and other workers who didn't qualify for this deduction
in the past. As this tax tip explains, work areas in residential
dwellings meeting certain requirements will qualify for an "office-in-home"
deduction. This tax tip discusses three tests you must pass to take
this deduction. Consider whether the area in question is the principal
location of business, is a meeting location for professional contacts,
or meets the deductibility requirements for unattached structures.
Don't disregard this deduction because you didn't qualify in the
past.
Luis I. Ingles III is
a certified public accountant based in Louisiana
-- Posted May 27, 1999
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