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What you get if you qualify for home office deductions: If your home office is your principal place of business under the rules that we discussed last week, the costs of travelling between your home office and other work locations will be deductible in full, regardless of whether the other work location is regular or temporary, and regardless of the distance. So what you then have are deductible transportation expenses, rather than nondeductible commuting costs.
If your use of your home office qualifies under any of the rules discussed last week, you may take business expense deductions for the following:
1. The "direct expenses" of the home office -- e.g., the costs of painting or repairing the home office, depreciation deductions for furniture and fixtures used in the home office, etc.; and
2. The "indirect" expenses of maintaining the home office -- e.g., the properly allocable share of utility costs, depreciation, insurance, etc., for your home, as well as an allocable share of mortgage interest, real estate taxes, and casualty losses.
Amount limitations on home office deductions: The amount you may deduct as a home office expense is subject to limitations based on the income attributable to your use of the home office. In addition, your residence-based deductions that aren't dependent on use of your home for business (e.g., mortgage interest and real estate taxes) and your business deductions that aren't attributable to your use of the home office will also impact your deductions.
Example 1: Say you operate your business out of a home office that occupies 20% of the space in your home. This year, your business grosses $50,000. The mortgage and real estate taxes on your home total $20,000, $4,000 of which is allocable to the home office. You have $5,000 of additional home office expenses (depreciation, utilities, etc.), and your business has $30,000 of expenses that aren't attributable to the use of your home office (secretarial and bookkeeping services, legal and accounting fees, advertising expenses, etc.). To figure out whether you can deduct your home office expenses, you first subtract the home office portion of the mortgage and real estate taxes ($4,000) from the business's gross income. This leaves you with $46,000. Then, from this, you subtract your business expenses that aren't attributable to your use of the home office -- $30,000. This leaves you $16,000. If this figure exceeds the amount of your remaining home office expenses ($5,000 in our example), you can deduct all of those expenses. If this figure is less than your remaining home office expenses, your deduction is limited.
Example 2: Let's look at the limitation of the deduction. Let's use the same facts and circumstances as we used in Example 1, but we'll assume that your remaining home office expenses were $25,000 instead of $5,000 -- you'd only be able to deduct $16,000 instead of the full amount. And the computation gets even more difficult if your business effectively earns money both in your home office and at other locations, because the limitation formula only takes into account the income attributable to the use of the home office.
Any home office expenses that can't be deducted because of the limitations may be carried over and deducted in later years.
Computers and related equipment: If your use of the home office qualifies under any of the rules discussed last week, you may be able to use the "expensing" provisions of section 179 of the tax code to deduct the cost of computers and related equipment that you use in the home office. In addition, those deductions will not be subject to the "listed property" restrictions that would otherwise apply. We discussed this in greater detail in a prior article titled "Deductions for Home Computers."
Effect of home office deductions on later sales of your principal residence: You should be aware that, if you claim any home office deductions with respect to a portion of your principal residence, when you sell the residence, any profit attributable to the portion used as a home office may not be eligible for the otherwise available $250,000/$500,000 exclusion for gain on the sale of principal residences. You can avoid this problem by using your entire property (including the portion you had used as a home office) as a principal residence for at least two of the five years ending on the sale date of your home, but this technique can get pretty complex. Another rule you should be aware of is that the gain from the home sale representing the post-May 6, 1997 depreciation you claim on the home office is not eligible for the home sale exclusion. For more information about home sale tax exclusions, check out these articles: Home Sale Tax Exclusions Part 1, Part 2, and Part 3.
As you can see, the office-in-home rules can get pretty ugly... and complicated. You really need to know that you are on firm ground before you consider claiming this deduction. You'll find much more information on the office-in-home rules when you read IRS Publication 587 at the IRS website
Please note that Roy cannot answer individual questions via e-mail. If you have tax questions, please ask them on the taxes message board. Thanks!