Although claiming a home office deduction used to be considered a sure fire way to get on the IRS’s short list for an audit, things are changing. Today, many more entrepreneurs (either by choice or by design) are working from home. Claiming legitimate expenses for home office space is less likely to set off warning bells now than it would have even a few years ago. There are some things you do need to keep in mind, though:
Should You Claim Your Home Office
To meet the most basic criteria for compliance, your work area must be used exclusively and regularly for business activities. It should be either your place of business or the location where you meet clients (or patients). Shared use as in, say, utilizing the dining area in your home for a weekend jewelry making business is not typically considered exclusive enough to meet the criteria.
One exception to the “exclusivity” part of the tax rule is for businesses like day-care facilities that may claim space used for business as well as non-business activities. Another exception is for square footage used for inventory storage and staging.
The best way to be sure your home office complies with the tax rules is to use a freestanding building on your property set aside for work use only. Most of us aren’t lucky enough to have a work bungalow tucked away in the backyard with separate electrical service, though. The next best arrangement is to have an entire room in your home annexed exclusively as an office or work space. That means it has measurable square footage surrounded by four walls and a door. It should contain only work related items too, like a desk, filing cabinets and a work computer. It should not contain a spare bed, seasonal clothing or other objects not related to your business.
If you are employed by someone else and have a home office, additional rules apply that you should discuss with your employer or tax consultant.
The first year you evaluate your home office as a separate expense, factors like your mortgage payment, power usage, internet access, insurance and other computations can get detailed and potentially confusing. If you do get audited, disallowed home office deductions add up fast. To avoid having to pay back taxes and penalties, one good approach, especially if you’re just starting out, is to let a tax consultant set up your small business and discuss the benefits and drawbacks of claiming a home office deduction with you. Going forward, you can use his outline and make minor adjustments to comply with changes in the tax laws from year to year.