The Home Office Tax Deduction
The Internal Revenue Service has issued new rules affecting the income tax deduction for the business use of a home. A "home" means a house, apartment, condominium, mobile home, or boat, including other structures on the property, but the term does not include any property used exclusively as a hotel or inn. The rules apply to individuals, trusts, estates, partnerships, and S corporations, but not to other corporations. Certain tests must be met to qualify for the home office deduction.
Nature of the Use
The use of the business part of the home must be exclusive, regular, and for a trade or business. "Exclusive use" means that a specific area of the home must be used only for business, not for personal purposes. The space does not need to be marked off from the rest of the home by a permanent partition, however. There are two exceptions to the exclusive-use requirement: storage of inventory or product samples for a wholesale or retail business located in the home; and operation of a day-care facility in part of the home. "Regular use" of part of the home as a business means that such use must be on a continuing basis, not occasional or incidental. The use of part of the home must be for a trade or business, not simply for any profit-seeking activity, such as working on personal investments.
If the taxpayer uses part of the home for business in the capacity of an employee, the deduction is available only if two additional conditions are met. First, the business use must be for the convenience of the employer. Second, the taxpayer must not rent all or part of the home to the employer while using the rented portion to perform services as an employee.
Nature of the Place
To qualify for the deduction, part of the taxpayer's home devoted to business must be one of the following: the principal place of business; a place where the taxpayer normally meets or deals with patients, clients, or customers; or a structure not attached to the home that is used only for the trade or business.
The primary consideration in determining whether a home office is a principal place of business is the nature and importance of the activities performed there, especially as compared with activities done elsewhere. If the relative importance of the activities does not clearly point to one location, the taxpayer should consider whether most of the time devoted to the business is spent at the home office. If it is, this weighs in favor of taking the deduction.
Beginning in 1999, a home office will qualify as a principal place of business for deduction of expenses if it is used exclusively and regularly for administrative or management activities of the trade or business and if there is no other fixed location where the taxpayer conducts substantial administrative or management activities. Examples of such activities include billing, recordkeeping, ordering supplies, making appointments, and writing reports.
The new rules make it easier to qualify for the deduction. Some circumstances that used to disqualify the home office as a principal place of business no longer do so. For example, without losing the deduction the taxpayer can: have others do administrative or management activities outside the home; conduct such activities at non-fixed locations, such as cars or hotel rooms; and even carry on such activities at fixed locations outside the home, but only occasionally. Also, the deduction will not be lost when the taxpayer chooses to use a home office despite having suitable space outside the home for business activities.
If the home office is not the principal place of business, it may still qualify for the deduction if it is where the taxpayer meets with patients, clients, or customers in the normal course of business, and their use of the home office is substantial and integral to the conduct of the business. Sporadic telephone calls and occasional meetings at home will not satisfy this test. The third way for a home office to qualify is if it is a separate free-standing structure, such as a studio, garage, or barn, that is exclusively and regularly used for the business. Such a structure need not also be a principal place of business or a meeting place for patients, clients, or customers.