The Home Office Deduction is another area that is confusing to taxpayers. According to the IRS
If you use part of your home for business, you may be able to deduct expenses for the business use of your home. These expenses may include mortgage interest, insurance, utilities, repairs, and depreciation.
However, there are two popular myths surrounding business use of a home.
- 1. Never take the home office deduction, it will trigger an audit.
- 2. If you do any work out of your home, you can take a deduction.
As with many things that are “common knowledge,” these two myths are almost true. Unfortunately, almost true is just enough to get you into trouble. It is always best to rely on authoritative resources. Tax professionals such as CPAs, tax attorneys, and enrolled agents refer to IRS publications and they keep abreast or IRS rulings and court decisions. They also take continuing education. This is much more dependable than relying on, “a friend who knows someone who . . .”
Let’s look at the first myth. The IRS does not publicize its audit selection criteria. However, there is no evidence to suggest that simply claiming a home office will increase the chance that you will be audited. Many taxpayers operate businesses out of home offices. The tax code specifically allows deductions for business use of a home, and the IRS provides instructions in Publication 535 Business Expenses and in Publication 587 Business Use of Your Home.
If there is an increased risk of audit, then it would have to do with improperly claiming a home office deduction. It may seem inconsistent to believe that claiming the deductions will not trigger an audit, while improperly claiming the deduction could increase the chances of being selected for an audit. However, consider that the IRS processes large numbers of tax returns from many different business types. This means that the service has a pretty good idea what typical taxpayers do. If you operate a business out of your home, then your home office deduction should look pretty much like the returns of similar businesses. In other words, reporting what you do and can document should not cause you any problems. Making something up might.
This leads us to myth number two. It is not true that simply working at home is sufficient to claim a home office deduction. The Business Use of Your Home section of Publication 535 Business Expenses explains:
To qualify to claim expenses for the business use of your home, you must meet both of the following tests.
- The business part of your home must be used exclusively and regularly for your trade or business.
- The business part of your home must be
- Your principal place of business; or
- A place where you meet or deal with patients, clients, or customers in the normal course of your trade or business; or
- A separate structure (not attached to your home) used in connection with your trade or business.
Do you run your business from your kitchen table? Is your home office a desk in your guest room? If so, you may not be meeting the first criteria. The only exceptions to exclusive use are for storage or inventory or for daycare facilities.
The second test has three parts. The first two essentially say that this is where you do your work, and you have no other fixed location where you work. If you do work in other fixed locations, then you should determine your principal place of business based on the importance of the work done or time spent at each location. Refer to Publication 535 and Publication 587 for the specifics. It is also always a good idea to consult with your trained tax professional.
There are two methods for claiming business use of your home on your Form 1040. The first is to report all your expenses. These expenses could include mortgage interest, insurance, utilities, repairs, and depreciation. The second method is called the safe harbor method, and it basically allow up to five dollars per square foot up for up to 300 square feet.
What’s the true story?
There is no reason to believe that claiming a deduction for business use of a home will trigger an audit. If you legitimately set aside a part of your home and use it exclusively as your principal place of business, you should claim the deduction. If you claim the deduction, you can either claim your actual expenses or use the optional safe harbor method.