Will a Home Office Deduction Trigger an IRS Audit?
Not if you do your homework. Get your hands on IRS publications and read about the home office deduction.
Lu Bauer
Nearly everyone has opinions on taxes, especially when it comes to starting a home-based business. The very first bit of free tax advice the novice entrepreneur will likely hear is: "Now you can deduct your house!"
Advice on home office deductions may be everywhere, but much of it is conflicting and frightening — especially when heaped upon other concerns associated with starting a business). Conflicting advice and fear of Internal Revenue Service audits unfortunately lead many business owners to avoid the home office deduction they are entitled to receive.
Failing to claim a home office deduction for fear of IRS repercussions is a truly unnecessary — and unfortunate — financial decision. The expense of running a home office can and should be claimed as a deduction. The best way
to safely claim this deduction is to thoroughly understand the IRS rules and how a particular business does or does not qualify. By gaining a firm grounding in the facts, home owners can be more confident when making deduction decisions.
For starters, let go of that fear of waving the red flag of audit. Prior to 1991, when IRS introduced Form 8829, the home office deduction was among the top 10 audit issues tracked by the IRS. Home-based businesses claimed the expenses for their home office on the Schedule C. The home expenses were not separately identified from the other expenses with, for instance, office
equipment repairs being claimed along with a portion of house repairs all on the same line. Since we are, by law, not allowed to claim home office expenses in excess of our net income, the IRS needed to check the calculations on many returns. The only way to do that was to audit returns that might have incorrect calculations or might not qualify.
Since 1991, however, business owners have been able to clearly calculate their home office deductions on Form 8829 and carry the single number for the deduction to their Schedule C. Now IRS can easily review, quite automatically, the calculations used for the deduction. IRS is currently more concerned with whether or not your home office is eligible for the deduction in the first place.
The basic rule is that you may claim a deduction for the expenses associated with the portion of your home used "regularly and exclusively" for your business. The business percentage is calculated by measuring the square footage of the area used for your business and dividing it by the total usable square footage in your home. Form 8829 leads you through the computations to
figure out how much you can claim of your home expenses such as mortgage interest, real estate taxes and depreciation, if you own your home (or rent expense, if you are renting your house), heating and other utilities, insurance, repairs, supplies. That's actually the easy part.
You may have a space in your home that is used "regularly" and "exclusively" for business, as the law requires, but in order to qualify your home work space must fall into one of the following categories:
1) The home space is the principal place of your business or,
2) If it's a secondary location, it is a place where you regularly meet and deal with customers.
3) The space is used for administrative work or management of the business and there is no other fixed location to conduct those activities or,
4) The space is used for business and is located in a separate structure not attached to the house.
Clearly, it is possible to use space in your home for business and have it not qualify for the home office deduction. Consider the Betsy who makes homemade blueberry jam in her kitchen, the only kitchen in her house. For sure, she is using part of her home for business, but it will not qualify because the area is also used to prepare meals for her family. Betsy may
have a separate office space, however, that she will be able to claim! But consider this, her partner may also use that office to bring home work from their job. Oops! That will disqualify Betsy¹s office because it’s not used exclusively for her business!
So, don't be afraid. Do your homework. Get your hands on the IRS publications and read the sections on the home office deduction thoroughly. Envision how your home will be used in your business. Figure it out ahead of time. And, if you need additional help, be sure to meet with a competent and conservative tax accountant; together you will be able to determine whether or not you will be entitled to the deduction.
LU BAUER, CPA is a money counselor and financial advisor in Brunswick. She is available for consultations (207-729-0531) with those who want to improve their relationship with money and better understand their business. Visit www.moneybalancingact.com for other articles helpful to individuals, families and owners of small businesses. Bauer was featured in the January 2007 issue of Down East Magazine.
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