How do I take a home office deduction? Will it get me audited if I take the deduction?
Everyone will tell you it is red flag, but so what? Don’t be afraid to take home-office deductions. Some people shy away when they could claim a legitimate home office tax deduction.

If you use part of your home regularly and exclusively for business  use, you may be able to deduct a part of the operating expenses and depreciation of your home. You can deduct certain expenses for the business use of a part of your home only if you use that part regularly and exclusively as:

1. Your principal place of business for an any trade or business in which you engage, or
2. A place to meet or deal with your patients, clients, or customers in the normal course of your trade or business

You can also deduct certain expenses for a  building not attached to your home if you use it regularly and exclusively for your trade or business. The regular and exclusive business must be for the convenience of your employer and not just appropriate and helpful for your job.

Starting in 1999, a home office will be considered a principal place of business if you perform administrative or management activities (such as billing) there and there is no other fixed location of that trade or business where you can conduct substantial administrative or management  duties of that trade or business. This change in the law resulted from a 1993 Supreme Court decision in which an anesthesiologist who handled his bookkeeping and business correspondence at home and treated his patients in hospitals was denied a home office deduction. In the wake of this decision, Congress changed the law to allow taxpayers a home office deduction in such circumstances.

Tip:  Don’t forget to take pictures of your home office to substantiate the deduction in the case of audits. 

Note: When you do not have a profit from your business, you are not able to take the home office deduction, but you can carry the deduction forward to future years.

Tip: The percentage of deductible home office expenses is normally based on the percentage of square footage the  business use in comparison to total square footage, but consider this method also: Calculate the amount of utilizes prior to conversion to a home office in comparison to the amount of utilities after conversion. For example the electric bill alone may go up substantially since you are now  using the home office . Business use can also be based on the number of rooms used for business, if all rooms are of approximately the same size.

 Home based business  deductions may include: utilities, gas, electric, sewage, trash, water, internet access, cable TV, repairs and maintenance, insurance, property tax, mortgage interest, household supplies, association dues, security expense.

Note: If you are eligible for the home-office deduction you will run into certain complications when you sell your home. Any depreciation you were allowed must be ‚recaptured. This means that you add up all the depreciation you were eligible for during the all the years you had a home office – whether you took the depreciation of not! – and pay tax on that depreciation when you sell your house.

Home  based business tax deduction examples:
Example 1:  Jimmy is a self-employed  electrician . Most of his time is spent at customer’s homes and offices installing and repairing items. He has a small office in his home that he uses exclusively and regularly for the administrative or management activities of his business, such as phoning customers, ordering supplies, and keeping his books.

He writes up estimates and records completed at his customers’ premises. He does not conduct any substantial administrative or management activities at any fixed location other than his home office. He not do his own billing. He uses a local bookkeeping service to bill his customers.

His  in house business office qualifies as his  main place of business for deducting expenses for its use. He uses the home office for administrative and managerial activities of his business and he no other fixed location where he conducts these administrative or managerial activities. His choice to have his billing done by another company does not disqualify his home office from being his principal place of business. He meets all the qualifications, including principal place of business so he can deduct expenses (to the extent of the income deduction limit) for the business use of his home.

Example 2: Paul is a self-employed anesthesiologist. He spends the majority of his time administering anesthesia and postoperative care in three local hospitals. One of the hospitals provides with a small shared office where he could conduct administrative or management activities.
Paul very rarely uses the office the hospital provides. He uses a room in his home that he has converted to an office. He uses the room exclusively and regularly to conduct all the following activities.

• Contacting patients, surgeons, and hospitals regarding scheduling
• Preparing for treatments and presentations
• Maintaining billing records and patient logs
• Satisfying continuing medical education requirements
• Reading medical journals and books

Paul’s home office qualifies as his principal place of business for deducting expenses for its use. He conducts administrative or management activities for this business as an anesthesiologist there and he has not other fixed location where he conducts substantial administrative or management activities for this business. His choice to use his home office instead of the one provided by the hospital does not disqualify his home office from being his principal place of business. His performance of substantial nonadministrative or nonmanagement activities at fixed locations outside his home also does not disqualify his home office form being his principal place of business. He meet all the qualifications, including principal place of business, so he can deduct expenses (to the extent of the deduction limit) for the business use of his home.

This excerpt was written by Joe D. Moughon, CPA. Joe is a CPA in Houston, Texas. He has written many publications in regards to taxes and the small business owner including: Small Business Tax Deductions.  If you found the information in the article above, please visit his web site for more in-depth information about Small Business Taxes.

Don’t forget, “It’s not what you earn that matters, it is what you get to keep that counts.”