A Taxing Question

Do you qualify for the oft-misunderstood home-office deduction?
Magazine Contributor
11 min read

This story appears in the February 1997 issue of . Subscribe »

Do you qualify for the oft-misunderstood home-office deduction?

Doesn't everyone seem to have an opinion when you are considering claiming a home-office deduction? Advice on the subject seems to be offered everywhere, but so much of it is conflicting and frightening. As a CPA with 17 years of tax experience, I have known many people who did not claim the home-office deductions that they were honestly entitled to, just because of this confusion.

This is too bad, and truly unnecessary. The best way to safely claim this deduction is to thoroughly understand the IRS rules and how your particular homebased business does or does not qualify. Take a closer look at these rules to get a firmer grounding in the real facts so you can be more confident when you make your deduction decision.

The first challenge you'll face in claiming the home-office deduction is getting past the fear that it will cause an IRS audit. Prior to 1991, when the IRS introduced Form 8829, the home-office deduction was among the top 10 audit issues tracked by the IRS. Homebased businesses claimed the expenses for their home office right on their Schedule C. Home expenses were not separately identified from other expenses, so, for instance, office-equipment repairs were reported on the same line as house repairs.

Since we are, by law, not allowed to claim home-office expenses in excess of our net income, the IRS needed to check the calculations on many returns. The only way they could do that was to audit the returns which might have incorrect calculations or might not qualify.

Now, on Form 8829, business owners are able to clearly calculate their home-office deductions and carry the single number for the deduction to their Schedule C. This makes it easier for the IRS to review, quite automatically by computer, the calculations used for the deduction.

Instead of the feared increase in audits of home-office deductions, IRS spokesperson Don Roberts confirms that by mid-1994, the issue wasn't even in the top 30.

"I am not aware of any current program targeting the home-office deduction for audit," Roberts says. The IRS is now less concerned with how much of a deduction you are claiming than with whether or not you are eligible in the first place.

I recommend the following advice to homebased business owners: Claim all the deductions to which you are confidently entitled, rather than foregoing a deduction just because you think it might cause an audit. If you are not confident that you are entitled to a home-office deduction, it is worth the effort to gain that confidence. Read IRS Publication 587, Business Use of Your Home (see sidebar below for ordering information), to get a good understanding of the rules. You may also want to consult with a professional tax preparer, accountant or attorney for a professional opinion of your particular work situation.

The following information will help get you started.

The basic rule is that you can claim a deduction for the expenses associated with the portion of your home used "regularly and exclusively" for your business. The business percentage is calculated by measuring the square footage of the area used for your business and dividing it by the total usable square footage in your home. Form 8829 leads you through the computations to figure out how much you can claim of your home expenses, such as mortgage interest, real estate taxes and depreciation, if you own your home (or rent expense, if you are renting your house), heating and other utilities, insurance, repairs and supplies. That's actually the easy part.

You may have a space in your home that is used "regularly and exclusively" for business, as the law requires, but it still may not qualify if it does not fall into one of the following categories: 1) It's the principal place of your business, or 2) If it's a secondary location, it's a place where you meet and deal with customers.

If your business will be primarily operated out of your home and the actual sales or services occur there, you'll have no problem. In this case, your home office is your principal place of business. If you have another business location but customers also come regularly to your home office, you qualify under the second part. How often you need to have customers coming to your home is not specified in the law, but IRS Publication 587 uses an example of an attorney who works 3 days a week in her city office and works 2 days a week in her home office. It says that because the attorney regularly meets clients at home, her home office qualifies for the deduction.

But you may get caught on the second condition. If you have an off-site location that is actually the principal place of your business, then chances are your home office, where you do the bookkeeping, is not a place you meet and deal with customers. In this case, you would not be eligible for the deduction, even though the space at home is really used only for legitimate business purposes.

I have several clients who provide professional services at an off-site office, but in order to preserve their right to the home-office deduction, they make sure to meet with a few clients regularly at the home office. Think of ways you can draw customers to your home office on a regular basis if this provision puts your deduction at risk.

Whether or not you are eligible to claim the home-office deduction recently became a little harder to understand. This is due to a 1993 Supreme Court decision, Commissioner v. Soliman.

Dr. Nader E. Soliman is an anesthesiologist who worked through three hospitals. As a solo practitioner, he maintained an office in his home, completely devoted to his business, where he did his scheduling, billing, follow-up calls, and continuing educational study. He absolutely needed the office, as there was no office provided at any of the hospitals. Nevertheless, the U.S. Supreme Court ultimately judged that his home was not his principal place of business.

The decision turned on the fact that much more of his professional time was spent in the hospitals than in his home office. His home office was a secondary place of business and the deduction was not allowed because he didn't meet with clients there.

This precedent can be pretty scary to a lot of homebased service businesses, such as home-improvement contractors, business and computer consultants, and home-inspection services. However, there may be some flexibility in determining just where your principal place of business is.

Melissa Bailey, owner of Paw Prints in Standish, Maine, came across this problem because she was doing pet grooming and photography in her customers' homes. "I had always been a craftperson, as well," says Bailey, "so I found a natural solution."

She began producing pet-related crafts, such as collars and bowls, in her home-business space, which were then sold through a catalog to her grooming clients. By increasing the work hours she logged at home, she was able to qualify her home as the principal place of her business. And since her home qualified as the principal place of her business, Bailey didn't have to worry about meeting with customers regularly at home.

Greg Dumond of National Detail Systems in Thousand Oaks, California, provides his dealers with fully equipped mobile systems for cleaning cars on-site. "Some of my dealers are offering free pick-up and delivery services so they can perform the work at their home-business location instead of on-site," says Dumond. Many of his dealers are also using home space, such as a garage, for storage of cleaning supplies.

If this sounds similar to your situation, I recommend you take a few steps to ensure that your home is seen as the principal place of your business. You will want to keep time records for at least a few months each year to establish your patterns of work and be able to show, should you be selected for an audit, that you spend more time there than anywhere else. The IRS is also interested in the relative importance of the activities you perform in each location, so keep records of what you are doing in each place as well as how much time you spend doing it.

So, don't be afraid. Do your homework. Get your hands on the appropriate IRS publications and read the sections on the home-office deduction thoroughly. Envision how your normal workdays will be structured; if you need additional help, be sure to meet with a competent and conservative tax accountant. Together you will be able to determine whether or not you will be entitled to the deduction.

How important is your business image? It's every bit as critical to your success as your marketing plan. How you are perceived by your customers--your image--shapes their expectations and buying decisions, helping to determine whether they'll come back, and influences what they'll say about you.

Building a positive image is definitely worth what it takes to get one. There are three key elements that go into creating a solid business image: vision, commitment and persistence.

1. Vision. Vision means knowing your business: who your customers are, what differentiates you from your competition, and how you want to be perceived. Only after you've answered those questions can you design an appropriate image.

What type of image best suits your business? If you work with computers, you'll want to create a business image that shows your company is on top of the latest business technologies. If you have a desktop-publishing or secretarial service, you'll want to create an image that demonstrates your attention to detail.

2. Commitment. Commitment is the willingness to follow through on creating your image. Everything a customer sees, hears or touches in connection with your business becomes part of its image. The physical appearance of your office or store--including the condition and availability of parking lot spaces, sidewalks, paint, sign condition, etc.--makes an impression.

But image doesn't stop at the door. What do customers see when they walk in? How are they greeted? Does your answering-machine message project professionalism? Your product packaging, stationery, invoices and shipping boxes all speak volumes. To create a strong business image, you must attend to details.

When Plain Folk, a retail store specializing in Early American handcrafts, opened in Riverton, Connecticut, owner Mark Moulton paid special attention to its image. The store interior strives to give an Early American feeling, with dried flowers hanging from the ceiling, muted lighting, and rustic display pieces. Moulton gave the merchandise tags an "old" look by hand-lettering the shop name and prices on brown paper stock. Shelf signs were hand-printed in chalk on old slate boards to further the image of antiquity.

"Packaging is everything," says Moulton. "Everything has to go together. When a customer comes in, we want her to feel that she's stepping back into the early 1800s, and we can't do that if we use glossy paper and plastic."

3. Persistence. Persistence means keeping with the program, day after day; dusting the display shelves when business is slow; answering the phone with a confident, friendly tone, even when you're feeling rotten; printing new stationery when your address or phone number changes, rather than inking in the corrections; checking and double-checking all correspondence for typos and grammatical errors; and making sure that everything about your business presents an image that is both first-class and consistent.

Building a positive business image is time-consuming but doesn't have to be expensive. And the time you spend on image will pay big dividends as you take your business from start-up to success.

--Grace Butland

Be In The Know

To arm yourself with an understanding of all the rules, call the IRS Publications number at (800) 829-3676, and ask for the following publications:

  • IRS Publication 334, Tax Guide for Small Business

  • IRS Publication 587, Business Use of Your Home (considered by many to be the Bible of home-office deduction information)

  • Form 8829 and Instructions

Contact Sources

National Detail Systems, 801 Mitchell Rd., #108, Thousand Oaks, CA 91320, (800) 356-9485.

Plain Folk, 21 School St., Riverton, CT 06065, (860) 379-0492.

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