40.12 Home Office Deduction
If you operate your business from your home, using a room or other space as an office or area to assemble or prepare items for sale, you may be able to deduct expenses such as utilities, insurance, repairs, and depreciation allocated to your business use of the area. Collectively, these expenses are deducted as a single write-off, called the home office deduction.
Exclusive and regular use.
To deduct home office expenses, you must prove that you use the home area exclusively and on a regular basis either as:
Filing Tip
Administrative (record-keeping) activity.
A home office meets the principal place of business test (Test 2) if: (1) you use it regularly and exclusively for administrative or management activities of your business and (2) you have no other fixed location where you do a substantial amount of such administrative work. Self-employed persons are the beneficiaries of this administrative/management rule. Employees usually may not take advantage of the rule because of the application of the convenience-of-the-employer test to an employee’s use of a home office; see the Example at 19.13. Examples of administrative and management activities include billing customers, clients, or patients; keeping books and records; ordering supplies; setting up appointments; forwarding orders; and writing reports.
According to the IRS, performance of management or administrative activities under the following conditions do not disqualify a home office as a principal place of business:
- You have a company send out your bills from its place of business (see Example 1 below).
- You do administrative or management activities at times from a hotel or automobile (see Example 2 below).
- You occasionally conduct minimal administrative or management activities at a fixed location outside your home.
- You have suitable space to do administrative or management work outside your home but choose to use your home office for such activities (see Example 3 below).
Caution
If you work at home and also outside of your home at other locations and you do not meet the administrative/management rule, deductions of home office expenses should be supported by evidence that your activities at home are relatively more important or time consuming than those outside your home.
Exclusive and regular business use of home area required.
If you use a room, such as a den, both for business and family purposes, be prepared to show that a specific section of the den is used exclusively as office space. For example, a real estate operator was not allowed to deduct the cost of a home office, on evidence that he also used the office area for nonbusiness purposes. A partition or other physical separation of the office area is helpful but not required.
Under the regular basis test, expenses attributable to incidental or occasional trade or business use are not deductible, even if the room is used for no other purpose but business.
Even if you meet these tests, your deduction for allocable office expenses may be substantially limited or barred by a restrictive rule that limits deductions to the income from the office activity. This computation is made on Form 8829 (40.15).
Filing Instruction
Multiple business use of home office.
If you use a home office for more than one business, make sure that the home office tests are met for all businesses before you claim deductions. If one business use qualifies and another use does not, the IRS will disallow deductions even for the qualifying use, see the following paragraph.
Employee with sideline business.
Employees who use a home office for their job and for a sideline business also should be aware of this problem. Most employees are unable to show that their home office is the principal place of their work (19.13). Claiming an unallowable deduction for employee home office use will jeopardize the deduction for sideline business use. This happened to Hamacher, who as a self-employed actor earned $24,600 over a two-year period from an Atlanta theater and a few radio and television commercials. He also earned $18,000 each year as the administrator of an acting school at the theater. For his job as administrator, Hamacher shared an office at the theater with other employees. He had access to this office during nonbusiness hours. He also used one of the six rooms in his apartment for an office. Because of interruptions at the theater, he used the home office to work on the school curriculum and select plays for the theater. In connection with his acting business, he used the home office to receive phone calls, to prepare for auditions, and rehearse for acting roles.
The IRS disallowed his deduction for both self-employment and employee purposes because Hamacher’s office use as an employee did not qualify. The Tax Court agreed. A single-office space may be used for different business activities, but all of the uses must qualify for a deduction. Here, Hamacher’s use of the home office as an employee did not qualify. He had suitable office space at the theater. He was not expected or required to do work at home. As the employee use of the home office did not qualify, the Tax Court did not have to determine if the sideline business use qualified. Even if it had qualified, no allocation of expenses between the two uses would have been made. By requiring that a home office be used “exclusively” as a principal place of business or place for seeing clients, patients, or customers, the law imposes an all-or-nothing test.
Filing Tip
Separate structure.
If in your business you use a separate structure not attached to your home, such as a studio adjacent but unattached to your home, the expenses are generally deductible if you satisfy the exclusive use and regular basis tests discussed earlier. A separate structure does not have to qualify as your principal place of business or a place for meeting patients, clients, or customers. However, an income limitation (40.15) applies. In one case, a taxpayer argued that an office located in a separate building in his backyard was not subject to the exclusive and regular business use tests and the gross income limitation. However, the IRS and Tax Court held that it was. The office building was “appurtenant” to the home and thus part of it, based on these facts: The office building was 12 feet away from the house and within the same fenced-in residential area; it did not have a separate address; it was included in the same title and subject to the same mortgage as the house; and all taxes, utilities, and insurance were paid as a unit for both buildings.
Day-care services.
The exclusive-use test does not have to be met for business use of a home to provide day-care services for children and handicapped persons, or persons age 65 or older, provided certain state licensing requirements are met. If part of your home is regularly but not exclusively used to provide day-care services, you may deduct an allocable part of your home expenses. You allocate expenses by multiplying the total costs by two fractions: (1) The total square footage in the home that is available for day-care use throughout each business day and regularly so used, divided by the total square footage for the home. (2) The total hours of business operation divided by the total number of hours in the year (8,784 in 2012).
If the area is exclusively used for day-care services, only fraction (1) applies.
In one case, the Tax Court held that utility rooms, such as a laundry and storage room and garage, may be counted as part of the day-care business area. The IRS had argued that because the children were not allowed in these areas, the space could not be considered as used for business. The Tax Court disagreed. The laundry room was used to wash the children’s clothes; the storage room and garage were used to store play items and equipment. Thus, the space was considered as used for child care even though the rooms were off limits to the children.
Storage space and inventory.
If your home is the only location of a business selling products, you may deduct expenses allocated to space regularly used for inventory storage, including product samples, if the space is separately identifiable and suitable for storage.