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The Expanded Home Office Deduction Rules Make It Easier For The Taxpayer To Qualify.



Every year, thousands of people perform some type of business activity in their homes. Until 1993, many of these people who had home offices qualified for tax deductions Tax deduction

An expense that a taxpayer is allowed to deduct from taxable income.


tax deduction

See deduction.
. [1] In 1993, the U.S. Supreme Court interpreted IRC (Internet Relay Chat) Computer conferencing on the Internet. There are hundreds of IRC channels on numerous subjects that are hosted on IRC servers around the world. After joining a channel, your messages are broadcast to everyone listening to that channel.  Sec. 280A in such a manner that it became very difficult for most taxpayers to qualify for a home office deduction. When Congress passed the Taxpayer Relief Act of 1997 (TRA TRA Training
TRA Transfer
TRA Transition
TRA Tennessee Regulatory Authority
TRA Telecommunications Regulatory Authority (Oman)
TRA Tax Reform Act (1976, 1984, or 1986)
TRA Teachers Retirement Association
 97), it included a provision that allows more taxpayers to qualify for a home office deduction. Although the TRA 97 was passed in 1997, the provision that pertains to home office deductions did not become effective until after December 31, 1998.

This article examines the rules concerning home office deductions, discusses other deductions that are closely associated with the home office, and examines potential pitfalls associated with the home office deduction. It is important to note that in defining the term home office; "home" can be a house, apartment, condominium condominium

In modern property law, individual ownership of one dwelling unit within a multidwelling building. Unit owners have undivided ownership interest in the land and those portions of the building shared in common.
, mobile home or boat. [2]

BACKGROUND

Pre-Soliman

Prior to the Soliman case, Section 280A (c)(1) stated that in order for a taxpayer to deduct de·duct  
v. de·duct·ed, de·duct·ing, de·ducts

v.tr.
1. To take away (a quantity) from another; subtract.

2. To derive by deduction; deduce.

v.intr.
 home office expenses, the office had to be used "exclusively" and on a "regular basis" as:

(1) The principal place of business for the taxpayer's trade or business, or

(2) A place of business which is used by patients, clients, or customers in meetings with the taxpayer in the normal course of business.

Principal Place of Business

The term "principal place of business" was, at that time, defined as the location where persons earn their income. This definition made it impossible for plumbers, electricians and interior decorators to qualify for the deduction because these people earned their income at locations other than in their offices. Both the IRS An abbreviation for the Internal Revenue Service, a federal agency charged with the responsibility of administering and enforcing internal revenue laws.  and the courts have stated that the taxpayer must be involved in a trade or business and that activities such as clipping (1) Cutting off the outer edges or boundaries of a word, signal or image. In rendering an image, clipping removes any objects or portions thereof that are not visible on screen. See scissoring. See also WCA.  coupons or reading investment magazines do not constitute a trade or business. [3]

Regular

The term "regular" means that a specific area of the house is used on a continuous basis. Occasional or incidental Contingent upon or pertaining to something that is more important; that which is necessary, appertaining to, or depending upon another known as the principal.

Under Workers' Compensation statutes, a risk is deemed incidental to employment when it is related to whatever a
 use does not meet the test. [4] Even if the area is not used for any other purpose, it still fails the test if the area is used only occasionally. Neither the courts, nor the IRS, have specifically stated how many hours per day (or per week) that the office must be used for business purposes. All available authority indicates that the time element depends on the circumstances CIRCUMSTANCES, evidence. The particulars which accompany a fact.
     2. The facts proved are either possible or impossible, ordinary and probable, or extraordinary and improbable, recent or ancient; they may have happened near us, or afar off; they are public or
. [5]

Exclusive

The term "exclusively" means that the office is only used for business purposes. If the area is used eight hours a day for business, but the children come in at night and play video games See video game console.  on the computer, the office fails the exclusive use test and the deduction is lost.

There are two exceptions to the "exclusive use" test. If the taxpayer is in the business of selling products, the area of the home that is used to store inventory does not have to meet the exclusive use test. [6] The storage space must be, however, a specific, and identifiable area.

Example

Sue is a cosmetics distributor. She uses her kitchen closet to store her inventory of cosmetics. Even though she uses the closet to store canned goods, as well, the area is still deductible That which may be taken away or subtracted. In taxation, an item that may be subtracted from gross income or adjusted gross income in determining taxable income (e.g., interest expenses, charitable contributions, certain taxes).  as part of her home office.

Another situation that is exempt from the exclusive use test is when the home is used regularly to provide day-care services to children, handicapped persons, or the elderly. The home office deductions for a daycare service is computed as follows:

Expenses x Square footage used for day care/Total square footage of home x Hours of operation per year/Total hours per year

Soliman v. U.S.

In the Soliman case, an anesthesiologist Anesthesiologist
A medical specialist who administers an anesthetic to a patient before he is treated.

Mentioned in: Anesthesia, General, Appendectomy, Parathyroidectomy

anesthesiologist
 was employed by three different hospitals, but was not provided an office at any of them. He spent a total of approximately 35 hours per week at the hospitals and another 10-15 hours per week at his home office where he kept patient records, performed billing functions and read medical journals. In its ruling, the Supreme Court established a two-part test to determine whether a home office does in fact constitute a principal place of business. The two parts are relative importance and time.

The first part of the test examines the functions performed at each location in an attempt to determine where the most important activities take place.

The time portion of the test compares the amount of time actually spent at each of the various locations. In order to pass this part of the test, more than 50% of the taxpayer's time must be spent working in the home office.

The Supreme Court concluded that Soliman failed to meet the relative importance test because the activities he performed at home were of an administrative and management nature. These tasks were not nearly as important as the activities he performed at the hospital, such as anesthetizing patients for surgery and conferring with other doctors. The decision stated that the medical procedures Dr. Soliman performed at the hospital constituted the "essence" of his business and, therefore, the home office was not his principal place of business. Furthermore, the Supreme Court ruled that since he spent considerably more time at the hospital than in his home office, he also failed the time test. Thus, his deduction was disallowed.

WHO QUALIFIES FOR THE DEDUCTION?

By amending IRC Sec. 280A (c) via TRA 97, Congress recognized that almost every business needs a location where the business owner can store records, complete paperwork and take care of other administrative tasks. Accordingly, the TRA 97 expands the definition of the term "principal place of business" so a deduction can be taken if:

(1) The home office is used to conduct administrative or management activities of the trade or business. If taxpayers are unable to qualify under the new test, they may still qualify for the deduction under the old "relative importance" and "time" test. [7]

(2) The taxpayer has no other fixed location in which to conduct a substantial amount of administrative or management activities. If an insignificant amount of management and administrative work is performed elsewhere, this will not disallow To exclude; reject; deny the force or validity of.

The term disallow is applied to such things as an insurance company's refusal to pay a claim.
 the deduction.

(3) The office is used exclusively and on a regular basis for a trade or business.

(4) If the taxpayer is an employee, the home office is maintained for the convenience of the employer.

Requirements three and four were in effect under the old law. These requirements must be met whether the taxpayer is attempting to qualify his office as the principal place of business under the old law or the new.

What Items are Deductible?

Deductible expenses include a pro rata [Latin, Proportionately.] A phrase that describes a division made according to a certain rate, percentage, or share.

In a Bankruptcy case, when the debtor is insolvent, creditors generally agree to accept a pro rata share of what is owed to them.
 percentage of real estate taxes, mortgage interest, utilities, insurance, and depreciation. [8] If customers visit the taxpayer's home on a regular basis, the cost of landscaping and recurring re·cur  
intr.v. re·curred, re·cur·ring, re·curs
1. To happen, come up, or show up again or repeatedly.

2. To return to one's attention or memory.

3. To return in thought or discourse.
 lawn care are included. [9] Repairs that benefit only the business portion of the home are classified as direct expenditures and are fully deductible. Examples include painting or recarpeting the office. Repairs that benefit the entire residence are classified as indirect expenditures and are deductible on a pro rata basis. Painting the entire house or replacing the roof are considered indirect expenditures. [10]

The following IRS guidelines guidelines,
n.pl a set of standards, criteria, or specifications to be used or followed in the performance of certain tasks.
 must be observed when computing computing - computer  depreciation on the office:

* Non-residential real property placed in service before May 13, 1993 is depreciated Depreciated may refer to:
  • Depreciation, in finance, a reference to the fact that assets with finite lives lose value over time
  • Depreciated is often confused or used as a stand-in for "deprecated"; see deprecation for the use of depreciation in computer software
 over 31.5 years, whereas nonresidential real property placed in service after May 12, 1993 must be depreciated over 39 years.

* If a building was placed in service before 1987, it can be depreciated using accelerated depreciation Accelerated Depreciation

Any method of depreciation used for accounting or income tax purposes that allows greater deductions in the earlier years of the life of an asset.

Notes:
The straight-line depreciation method spreads the cost evenly over the life of an asset.
. If it was placed in service after 1986, the taxpayer must use straight-line depreciation A method employed to calculate the decline in the value of income-producing property for the purposes of federal taxation.

Under this method, the annual depreciation deduction that is used to offset the annual income generated by the property is determined by dividing the
.

* The amount to be depreciated is the lower of the fair market value of the residence at the time it is placed in service or the adjusted basis, which is the original purchase price, plus the cost of any improvements less any allowance for cost recovery.

The first step in computing depreciation is to multiply mul·ti·ply
v.
1. To increase the amount, number, or degree of.

2. To breed or propagate.
 the percentage of the residence used for business by the smaller of the adjusted basis or the fair market value at the time placed in service. The resulting figure is the depreciable depreciable

Of, relating to, or being a long-term tangible asset that is subject to depreciation.
 basis. Next, the depreciable basis is multiplied mul·ti·ply 1  
v. mul·ti·plied, mul·ti·ply·ing, mul·ti·plies

v.tr.
1. To increase the amount, number, or degree of.

2. Mathematics To perform multiplication on.
 by the appropriate percentage from a table to determine the depreciation deduction. Tables are available in Revenue Procedure 87-57, 1987-2 CB 687.

The depreciation in Table I is used the first year an asset is placed in service. The percentages are based on an asset life of 39 years, the Years, The

the seven decades of Eleanor Pargiter’s life. [Br. Lit.: Benét, 1109]

See : Time
 straight-line method Noun 1. straight-line method - (accounting) a method of calculating depreciation by taking an equal amount of the asset's cost as an expense for each year of the asset's useful life
straight-line method of depreciation
, and the mid-month convention. Since the residence in the following example was first placed in service during April, the mid-month convention requires that 8.5 months be used to calculate the cost recovery allowed--eight months for May through December and one half month for April. The computation Computation is a general term for any type of information processing that can be represented mathematically. This includes phenomena ranging from simple calculations to human thinking.  is as follows:

100%/39 X 8.5/12 = .01819

In subsequent years, the applicable percentage is: 100%/39 = 2.5641

Example

In April 1999, Dustin began using one room in his house for business purposes. The room constitutes 10% of the home's total square footage. The adjusted basis of the residence (not including land) is $100,000. In April the fair market value of the house (not including land) was $113,000. Since the adjusted basis is less than the fair market value, the adjusted basis will be multiplied by 10% to obtain the depreciable basis of $10,000. Because the residence was placed in service during April, the fourth month of the year, the $10,000 basis will be multiplied by 1.819% (.01819) resulting in a depreciation deduction of $181.90.

Computing the Amount of the Deduction

The home office deduction for a sole proprietorship A form of business in which one person owns all the assets of the business, in contrast to a partnership or a corporation.

A person who does business for himself is engaged in the operation of a sole proprietorship.
 is reported on Schedule C of Form 1040. Form 8829 "Expenses for Business Use of Your Home" must also be attached.

The amount of the home office deduction is limited to the difference between the business gross income and the non-home office business expenses such as advertising, salaries and supplies. Thus, the home office deduction can only be large enough to reduce net income to zero. The deduction cannot create or increase a net loss. [11]

The order in which home office deductions are allowed to offset gross income is important. The first items deducted de·duct  
v. de·duct·ed, de·duct·ing, de·ducts

v.tr.
1. To take away (a quantity) from another; subtract.

2. To derive by deduction; deduce.

v.intr.
 are those that would have been allowed anyway; e.g., mortgage interest, property taxes, and casualty losses if any. The next deductions allowed are those deductible by any business activity, such as utilities and repairs. Finally, the taxpayer may deduct depreciation. Only the business percentage of the home may be depreciated. Any expenses that exceed the net loss limitations are carried over to subsequent years, subject to the same rules that were in effect the year the loss took place. The example below illustrates these rules.

The remaining depreciation of $200 ($900 minus $700) may be carried over into future tax years.

As with all deductions, record keeping is important. The taxpayer should keep a separate business checking account, as well as a log of business meetings with clients, and save business receipts.

It Just Keeps Getting Better and Better

For most taxpayers, travel from their home to their first business stop of the day is a non-deductible commuting expense. Likewise, the trip home in the evening from the last business stop of the day is non-deductible. As an added bonus for those taxpayers who qualify for the home office deduction, all business-related travel costs from the taxpayer's home office to clients' offices and back are deductible.

Another bonus associated with the home office deduction is a special rule for property available for both business and personal use. This property is known as "listed property." Computers are normally subject to the listed property rules of IRC Section 280F. Listed property can be expensed or depreciated on an accelerated basis only if it is used more than 50% of the time for business purposes. This requirement results in a tremendous amount of detailed record keeping. However, there is an exception to this rule for computers used in a business establishment. [12] And, a home office qualifies as a business establishment. Thus, taxpayers who qualify for a home office deduction are spared a great deal of recordkeeping regarding the use of their computers.

I Knew There Was a Catch

When a personal residence is sold and the taxpayer has owned and lived in the house as a personal residence for at least two of the five years prior to the sale, up to $250,000 of the gain ($500,000 if married filing jointly Married Filing Jointly

A filing status for married couples that have wed before the end of the tax year. They can record their respective incomes, exemptions and deductions on the same tax return. Married filing jointly is best if only one spouse has a significant income.
) is tax free.

It should be noted that depreciation taken after May 6, 1997 may have to be recaptured. Generally, recapture recapture n. in income tax, the requirement that the taxpayer pay the amount of tax savings from past years due to accelerated depreciation or deferred capital gains upon sale of property. (See: income tax)


RECAPTURE, war.
 refers to the portion of accelerated depreciation that is treated as ordinary income at the sale of the property. However, this type of recapture occurs even though no accelerated depreciation has been claimed. This recaptured depreciation is not treated as ordinary income but is taxed at 25%.

Example

A single taxpayer in the 28% tax bracket Tax Bracket

The rate at which an individual is taxed due to a particular income level.

Notes:
Each income class is taxed at a different level. Generally, the more you make the more you are taxed.
 used a portion of his home as an office and claimed depreciation of $9,000, of which $3,000 was taken after May 6, 1997. The residence sold at a gain of $200,000. Assuming that the ownership and use tests of Sec. 121 were met, the only tax consequences are that the $3,000 of depreciation taken after May 6, 1997 is recaptured and taxed at 25%, resulting in a tax liability of $750.

SUMMARY

In 1993, the Supreme Court ruled that in order for a taxpayer to claim a deduction for an office in the home, the office must constitute the taxpayer's principal place of business. The Supreme Court defined this term as the place where the most important aspect of the taxpayer's trade or business is performed. This ruling prohibited pro·hib·it  
tr.v. pro·hib·it·ed, pro·hib·it·ing, pro·hib·its
1. To forbid by authority: Smoking is prohibited in most theaters. See Synonyms at forbid.

2.
 a large number of taxpayers from claiming a home office deduction.

Congress passed the TRA 97 to overcome the Supreme Court's ruling. This made the home office deduction available to anyone who uses a home office for either managerial or administrative functions, even though the actual work is performed elsewhere.

Many taxpayers believe that claiming a home office deduction will almost guarantee an audit. However, the authors believe that keeping good records associated with the business use of the home should prevent any IRS adjustments. A business checking account with cancelled checks, separate telephone lines, and a diary of meetings with clients are the types of documentation needed to survive an audit.

Lee Daniel, MPA MPA

medroxyprogesterone acetate.
, CPA (Computer Press Association, Landing, NJ) An earlier membership organization founded in 1983 that promoted excellence in computer journalism. Its annual awards honored outstanding examples in print, broadcast and electronic media. The CPA disbanded in 2000.  is an Associate Professor of Accounting at Sorrell College of Business at Troy State University in Troy, AL.

Dr. Leonard G. Weld is an E.H. Sherman Professor of Accounting and Chair of the Accounting and Finance Department at Sorrell College of Business at Troy State University in Troy, AL.

References

(1.) Soliman v. Com., 93-1 USTC USTC University of Science and Technology of China
USTC United States Tax Cases (Commerce Clearing House)
USTC United States Transportation Command (see USTRANSCOM) 
 [footnote Text that appears at the bottom of a page that adds explanation. It is often used to give credit to the source of information. When accumulated and printed at the end of a document, they are called "endnotes."  number] 50,014; 113 S.Ct. 701 (1993).

(2.) Sec. 280A (f)(1)(A).

(3.) J.A. Moller v. U.S., 83-2 USTC [footnote number] 9698; 721 F2d 810 (CA-FC).

(4.) Prop. Reg REG,
n.pr See random event generator.
. [sections] 1.280A-2 (c).

(5.) Prop. Reg. [sections] 1.280A-2 (h).

(6.) Sec. 280A (c)(2).

(7.) Sec. 280A(c)(1)(c).

(8.) Sec. 280A (f)(4).

(9.) Hefti v. Comm See comms. ., CCH CCH Colegio de Ciencias y Humanidades (Spanish)
CCH Certified Clinical Hypnotherapist
CCH Cook County Hospital
CCH Certified in Classical Homeopathy
CCH Country Club Hills (Fairfax City, VA, USA) 
 Dec. 44,527 (M); 54 TCM (1) (Trellis-Coded Modulation/Viterbi Decoding) A technique that adds forward error correction to a modulation scheme by adding an additional bit to each baud. TCM is used with QAM modulation, for example.  1555.

(10.) Prop. Reg. [sections] 1.280A-2 (i) (3).

(11.) I.R.C. Sec. 280A (c)(5).

(12.) Sec. 280F(d)(4)(6).
                          First Year MACRS Table
                         For Non-residential Real
                        Property Placed in Service
                            after May 12, 1993
FIRST MONTH OF
BUSINESS USE   PERCENTAGE TO USE
1 (January)         2.461%
2                   2.247%
3                   2.033%
4                   1.819%
5                   1.605%
6                   1.391%
7                   1.177%
8                   0.963%
9                   0.749%
10                  0.535%
11                  0.321%
12 (December)       0.107%


Example

Derek is a taxidermist who uses a room in his house regularly and exclusively for business. The floor space used for business constitutes 10% of the floor space of the entire residence. Gross income from the business is $10,000. Expenditures for advertising, supplies, and the salary of a part-time assistant total $8,000. Derek incurs the following home office expenses:
Property taxes on residence                 $ 3,000
Interest expense on residence                 6,000
Utilities, repairs and insurance on
  residence                                   4,000
Depreciation on business portion of the
  residence                                     900
Derek's home office deduction is
  computed as follows:
Gross income                                $10,000
Less: Other business expenses                 8,000
                                            $ 2,000
Less: Business portion of taxes (10% of
  $3,000)                               300
Business portion of interest (10% of
  $6,000)                               600     900
Remaining income                            $ 1,100
Less: Business portion of
utilities and insurance (10% of 4,000)          400
                                              $ 700
Less: Depreciation on business portion
      ($900, but limited to remaining
  income)                               700
  Net Income of the business                    -0-
COPYRIGHT 2000 National Society of Public Accountants
No portion of this article can be reproduced without the express written permission from the copyright holder.
Copyright 2000 Gale, Cengage Learning. All rights reserved.

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Author:Daniel, Lee; Weld, Leonard G.
Publication:The National Public Accountant
Geographic Code:1USA
Date:Dec 1, 2000
Words:2811
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