The Home Office Tax Deduction

Requirements Relaxed for Tax Year

With more small businesses being operated from home-based locations we are often asked about home-office tax deductions. Today, many entrepreneurs are starting up internet consulting and other types of businesses that are, in fact, operated exclusively from the individual's home. It is important to be aware of the tax considerations in this area.

Starting with tax year 1999, the home-office deduction requirements were relaxed somewhat which could allow more self-employed people to take a deduction for businesses they operate from their homes. For example, in situations where the business owner does not have any other location where substantially all administrative activities are performed, expenses incurred to operate the home-based business are probably deductible. Therefore, it is now possible that consultants and salespeople, for example, will qualify, as well as, those taxpayers who previously qualified under the more restrictive requirements. Under the earlier requirements it was possible to take a deduction if the home-office was your principal place of business, a place where you regularly met with clients or customers, or was located in a separate structure on your property.

Self-employed individuals will have more to gain from a home-office deduction than will employees since the deduction for the latter only qualifies as a miscellaneous itemized deduction which is subject to a 2% of AGI floor. Also, as an employee, the purpose of your home office must be a requirement of your employer as a necessary part of the business.

For those that qualify, deductions can be taken for repairs, mortgage interest, taxes, utilities and depreciation (as a percentage based on proportionate usage of the office space to the home). In addition, travel costs between your home office and the first and last appointment of the day become deductible. The overall deduction cannot, however, exceed the net income of your business. Therefore, depending on the income generated by your business and the actual extent of home-office space used, your deduction may be small.

Mortgage interest, real estate taxes and other direct expenses not related to your home office must be deducted from income first. To the extent you still have net income you can then deduct repairs, utilities and depreciation on the business portion of your home. If these expenses then exceed net income the excess can be carried over to the following year. As in all good tax strategy issues, good record-keeping and documentation are very important.