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Home-office deduction frequently misunderstood

Posted online

by Cary G. Jones

for the Business Journal

The home-office deduction is one of the most misunderstood of all tax deductions, in part, because of the numerous requirements that must be met to claim the deduction. The new tax law liberalizes home-office rules so that more people may ultimately claim the deduction.

However, this year is not the time to start counting on the deduction if you haven't previously met the requirements. The new tax rules affecting home offices don't go into effect until 1999. For now, you'll have to comply with the current law.

Current rules.

To qualify for the home-office deduction in 1997 and 1998, you must use your home office exclusively and regularly as your place of business. Exclusively essentially means you and your family don't use your office for another purpose, such as family room or guest room.

An office will generally meet the exclusive test if you limit its use solely for your business or trade. And you must regularly work at that trade or business in the office. Even if you maintain a home office solely for, say, selling crafts, but you do this only on an occasional basis, you won't qualify for the deduction.

In addition, you generally must use your home office as your principal place of business. This means that it must be the place where you conduct your most important or significant business functions. If you don't meet this criteria, the home office must be a place where you meet to deal with clients and customers in the normal course of your business.

Under the current rule, you may not deduct the cost of a home office if you use the office only to do administrative work. In fact, the IRS has challenged taxpayers who have tried to claim the deduction on this basis.

What's new.

Beginning in 1999, a home office will qualify as a principal place of business if both the following conditions are met:

?The home office is used by the taxpayer to conduct administrative or management activities of a trade or business.

?There is no other fixed location of the trade or business where the taxpayer conducts substantial administrative or management activities of the trade or business.

Under these rules, even if the taxpayer has a fixed location away from home where it is possible to perform administrative or management activities, the taxpayer may still be able to claim the deduction if such work is actually done in the home office.

The tests regarding the regular and exclusive use of the home office still apply. Also, the rules will continue to limit an employee's home-office deduction to cases where the home office is for the convenience of the employer.

How much is the deduction worth?

Although direct expenses, such as repairs to your home office, are fully deductible, indirect expenses such as the cost for utilities, mortgage interest and real estate taxes are based on the percentage of your home used for your business.

So, if you have a very small space allocated for your office, your deduction may be small. You can also claim a depreciation deduction for the portion of your home used for business, but this must stretch over 39 years.

Here's an example: If you have 2,000 square feet of living space and your home office occupies 200 square feet, you'll be able to deduct one-tenth of your indirect home-office expenses. If these expenses total $30,000 over the course of a year, your home-office deduction will be worth $3,000.

Keep in mind that the key to claiming any deduction is documenting all qualified expenses. So, whether you're planning to take a home-office deduction this year, or think you'll qualify in 1999, set up a good record-keeping system as soon as possible.

(Cary G. Jones is a CPA and senior manager with the Springfield office of Baird, Kurtz & Dobson, CPAs.)

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