(This is Part 7 of an eight-part series. See Part 1, Part 2, Part 3, Part 4, Part 5, Part 6 and Part 8.)
Whether you are a renter or a homeowner and you use part of your residence for your full- or part-time business, you probably qualify for the special home business tax deduction to save on your income taxes. It doesn’t matter if you are self-employed or if you are an employee whose employer doesn’t provide suitable workspace and expects you to work at home.
However, if you bring work home from the office because you prefer working at home, then you won’t qualify for the generous tax savings offered by the home business tax deduction.
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For example, if you are a teacher who prefers grading student papers at home while watching television, but your school provides suitable workspace, you don’t qualify for this deduction. However, if the school is unsafe after work hours, then your home office deduction is justified.
EMPLOYEES WORKING AT HOME HAVE A SPECIAL TEST. The Internal Revenue Service imposes a special test for employees who work at home. It is called the “convenience of the employer” test.
If your employer doesn’t provide suitable workspace, then you probably meet this test. Examples include outside salespeople, computer entry clerks, and telephone order takers working from home.
SELF-EMPLOYEDS MUST PASS THE PRIMARY BUSINESS LOCATION TEST. To qualify for the Internal Revenue Code 280A home business tax deductions, whether you run a full- or part-time business from home, your residence must either (1) be used to meet with patients, clients or customers, or (2) used for administrative activity if you have no other fixed business location.
This tax law change was primarily caused by the 1993 U.S. Supreme Court decision denying Dr. Nader Soliman, an anesthesiologist, any home business deduction although he spent many hours on administrative work and reading professional medical journals in his condominium. Because Soliman spent the majority of his work time at various hospitals, the court denied his home business deductions. Today, thanks to a tax law charge, Soliman is allowed to deduct his applicable home office expenses.
In 1999, Congress changed the tax law to allow self-employeds, such as Soliman, to deduct their home business expenses if the residence is their “primary business location.”
Other examples include a self-employed handyman, plumber and bookkeeper whose residences are their “primary business location,” even if they spend most of their working hours at other job locations.
EVEN A PART-TIME BUSINESS CAN QUALIFY. Whether you work full- or part-time from home, if you meet the “primary business location” or “convenience of the employer” test, then part of your home operating costs are tax-deductible as business expenses.
For example, if you sell Amway, Mary Kay, or Avon products from your home, and you store inventory and supplies in your home business area, you may qualify if your residence is your primary business location.
However, the home use must be a business, not a hobby or investment. To illustrate, in the tax case of Joseph Moller, 553 Fed.2d 1071, Moller earned 98 percent of his income from his investment business, operated from his home. But the U.S. Court of Appeals denied his home business deductions because Moller was a passive investor in stocks and bonds. However, if he was an active “day trader” with frequent transactions, his home office deductions probably could have qualified.
The leading U.S. Tax Court decision on this issue is Dr. Edwin Curphey, 73 T.C. 61. Although Curphey was a full-time dermatologist at a hospital, he managed his rental properties on a part-time basis from his home office. The Tax Court ruled he was entitled to deduct applicable home office expenses for his part-time property management business.
“EXCLUSIVE BUSINESS AREA” IS REQUIRED. Whether full- or part-time home business use is involved, there must be an “exclusive business area,” which is not also used for personal or family purposes.
However, the exclusive business area need not be a full room. The part of a room where you keep your business supplies and equipment can qualify. However, it cannot be shared use.
To illustrate, entertaining business clients at home clearly doesn’t qualify. Neither does using your kitchen table for your part-time bookkeeping business if the family also eats meals there.
HOME BUSINESS DEDUCTIONS ARE BASED ON SQUARE FOOTAGE. The percentage of your home business deductions depends on the square footage of your residence set aside for exclusive business use. Time spent on your business doesn’t matter.
To illustrate, suppose you rent or own a 2,000-square-foot house or apartment. You use one bedroom for your home office. It is 400 square feet. Therefore, 20 percent of applicable household expenses are deductible as business expenses. The same rule applies if your business area is in a separate building on your premises, such as a detached garage.
The tax result is 20 percent of your applicable home expenses such as insurance, utilities, repairs, mortgage interest, property taxes and rent become deductible business expenses.
But 100 percent of some home business costs are fully deductible. Examples include your business telephone line (if you also have a personal telephone line), business computer DSL or broadband fees, and painting or improvement costs for the business area.
BUSINESS EQUIPMENT MAY BE FULLY DEDUCTIBLE. For qualifying business equipment bought and placed in service in 2005, such as a home business computer, the business owner can elect to deduct (rather than depreciate) up to $105,000 of the cost. But business equipment costs exceeding $105,000 must be depreciated over their useful life.
However, for a business automobile placed in service in 2005, the maximum expensing deduction is $2,960, although qualifying sport utility vehicles used in a business may be deductible up to $25,000.
HOME BUSINESS AREA IS DEPRECIABLE. Homeowners can depreciate the exclusive business area of their house or condominium. Using the example above, if your home office occupies 20 percent of your home’s square footage, then you can depreciate 20 percent of the house’s cost (excluding non-depreciable land value) on the 39-year commercial property straight-line basis.
However, IRS Regulation 2002-142 says although business use of your home won’t affect entitlement to the Internal Revenue Code 121 principal residence sale $250,000 or $500,000 exemption, the total depreciation deducted must be “recaptured” and taxed at a special 25 percent federal tax rate.
SPECIAL TAX BREAK FOR AUTO EXPENSES STARTING AT HOME. If you begin your workday from your home business location, and you use your automobile or truck to visit customers or work locations, your business mileage expense becomes tax-deductible when you drive away from your residence.
For 2005, the deduction is 40.5 cents per mile from Jan. 1 to Aug. 31, 2005, and 48.5 cents per mile from Sept. 1 to Dec. 31, 2005. But you must keep a daily mileage record.
LIMIT ON HOME BUSINESS EXPENSES. However, home business expenses are limited. When subtracted from the income of your home business, home office costs cannot create a tax loss to shelter your other ordinary taxable income.
SUMMARY: Whether full- or part-time, home business use can produce substantial tax savings. Employees and self-employeds, as well as renters and homeowners, can qualify if they meet the tests explained. For full details, please consult your tax adviser.
Reprints of the entire eight-part 2006 Realty Tax Tips series are now available for $5 from Robert Bruss, 251 Park Road, Burlingame, CA 94010 or by credit card at 1-800-736-1736 or instant Internet PDF delivery at www.bobbruss.com.
(For more information on Bob Bruss publications, visit his
Real Estate Center).
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