Photograph by Kathy De La Torre
In this Los Gatos Weekly-Times photograph, Pam Thiesson is shown in her home office where she runs her business, TimeSavers.
Deducting home office not always wise
By Sue DeRosier
The changing landscape of home design currently includes either an extra bedroom or alcove for a home office. Considering the large number of people who are now self-employed or telecommuting for their companies, this desired element in a home has become a defining area for many homebuyers. The tax benefit of working from home, however, hasn't completely materialized for all those eligible to take it.
On Jan. 1, 1999, the Internal Revenue Service (IRS) implemented a revised tax deduction policy that, in theory, allows more home-based entrepreneurs to deduct the expenses from their businesses off their personal income tax returns. Prior to January 1999, the allowance for taking a home office deduction was extremely narrow.
The defining case that turned the tide involved an anesthesiologist from the East Coast who used his home office to make appointments, bill clients, call doctors and study medicine. Although he worked in several hospitals in the area, none of them provided an office or "workspace" for him to do administrative tasks. After being audited by the IRS and required to repay the deductions, the doctor took his case to court--all the way to the Supreme Court, which eventually ruled against him, stating that the hospitals were his primary place of business because that is where he earned his income.
The new law allows homeowners to take the home office deduction if a) a part of the home is used regularly and exclusively as a home office (i.e., not as a family room or spare bedroom), b) the home office is used to conduct administrative or management activities of the homeowner's trade or business, and c) there is no other fixed location where substantial amounts of the business are conducted.
One group that has to be careful about claiming the home office deduction is the growing legion of telecommuters in the valley. Employees of corporations can only take the home office deduction if the office is "expressly used for the convenience of the employer." For example, one local semiconductor equipment manufacturer has a goal of having 15 to 20 percent of its employees work from home by 2002. In this case, if an employee elects to telecommute and his or her manager approves the request, the employee could be eligible for the home office deduction as it would be at the 'convenience of the employer.'
If a homeowner meets the requirements for home office use and wishes to take the deduction, the next step is calculating the amounts that can be applied and determining if the deduction is worth taking at all. As there are reverse tax implications to the homeowner once he or she decides to sell the home, most tax advisors recommend not taking the deduction if the homeowner plans on selling the home soon.
"The depreciation that has been taken on the home office deduction is recaptured once the home is sold if the homeowner/business person has used or maintained that office in the last two years leading up to the sale," said Tom L. Hall, a CPA in Cupertino. "The only way around this law is if the office and business has either been removed from the home completely or closed for two or more years; otherwise, the taxpayer will have to pay back some of the tax savings earned over the years."
In other words, if the homeowner took a total of $25,000 in home office deductions over a period of 15 years, he or she will be taxed on that $25,000 at the time the home is sold. The recapture tax went into affect with the Tax Relief Act of 1997. According to Hall, "It is one of the offsets of the capital gains forgiveness exemption included in the 1997 Relief Act."
Taking the home office deduction in Santa Clara Valley is another issue to consider according to Hall and H&R Block. The deduction is based on the original cost basis of the home so if someone purchased the home many years ago, the percentage of tax savings will be much less than if it had been based on the values of today's home.
"For tax preparation, the home office space is calculated as a percentage of the square feet of the home--this usually equates to about 4 to 10 percent of the home's value," adds Hall. "If the home cost $150,000 10 years ago but is worth one million today, the depreciation is taken only on the original $150,000. Where the deduction has more benefit is on homes purchased during the current market where costs are so high."
So, exactly what is included in the home office deduction? A sole proprietor can deduct 100 percent of expenses directly related to the home office space. For example, computers, fax machines, office telephone line, utilities, painting, cleaning and the premium on the homeowner's insurance policy all qualify as allowable expenses.
In addition, the IRS says that the homeowner can deduct a percentage of indirect expenses that relate to the entire residence including mortgage interest, property taxes, association fees, utilities, security monitoring, garbage pickup, general maintenance and repairs and insurance.
According to Smart Money magazine, knowing what to deduct is the easy part--figuring out how much of the indirect expenses can be written off is the harder part. Form 8829, Expenses for Business Use of Your Home, directs people to use the square footage method (take the square footage of the home office and divide that by the total square footage of the living space to come up with a percentage), but according to tax advisors in the field, any "reasonable method" can be used to compute business use for indirect expenses. For example, the simplest method is to count the number of the rooms in the home and divide so if there are 10 rooms in the house and one is used as an office 10 percent of indirect expenses can be deducted.
The determination of whether taking the home office deduction is worth the effort or not really depends on several factors--individual tax brackets, length of time in the home and how long will the homeowner be staying there, and accumulation of all income/expense-related factors.
If you have a home-based business and want to learn more about home office deductions and other home-based business issues, visit the IRS website at www.irs.gov, or consult with your local tax advisor.
Saratoga, California Since 1955
