If you have a home based business, eBay, or online business, one of your biggest tax deductions may be your home office.  Here are some tax tips to help you get the most out of your home office.

Qualifying for the home office tax deduction:

Your home office qualifies for the home office tax deduction if it is your principal place of business, and you use it regularly and exclusively for business.

To pass the ‘place of business’ test, your home office must be the principal place you conduct your business, or a place where you regularly meet with clients or customers, or it must be a separate structure not attached to your home.

Regular and exclusive use means that you spend at least 10-12 hours per week conducting business in your home office, and that you don’t use this room for other purposes.  For example, if you use part of the room as a laundry room or children’s play room you may not qualify for the home office deduction.

A good example of a home office that would qualify for the home office
tax deduction is a spare bedroom that is used only to operate your home
based or online business out of.  A poor example of a home office – and
one which probably would not qualify for the home office tax deduction
- is using your dining room or kitchen as a home office.

Expenses that you can deduct as part of the home office tax deduction:

Expenses that can be deducted include mortgage interest, real estate
taxes, utilities, insurance, repairs, security, and depreciation.

If you itemize deductions, chances are you are already deducting your
mortgage interest and real estate taxes.  However, deducting the
business use of these expenses on the home office deduction schedule
reduces your business income, which reduces your self employment tax.
This results in much greater tax savings than just deducting these
expenses on the itemized deduction schedule.

Only the business use percentage of these expenses can be deducted.
The business use percentage is calculated by dividing the square
footage of the office space by the square footage of the home, or by
dividing the number of rooms you use for business by the number of
rooms in your home.

Direct expenses, such as repairs made solely to the room used for your
home office, or telephone lines installed just for business use, can be
deducted in full.

Indirect expenses, such as mortgage interest and real estate taxes
should be allocated between the home office deduction and your itemized
deductions to get the greatest tax benefit.

Your home office tax deduction is calculated on Form 8829, Expenses for Business Use of Your Home.

Home office deduction limitations:

Deduction limited to profit: Your business must earn a profit to take
the home office tax deduction.  If your home office expenses are larger
than your business profits, you must carry the excess expenses forward
to future years.

Depreciation recapture:  In addition to mortgage interest, real estate
taxes, utilities, etc., you can also take a deduction for the
depreciation of your home on the home office tax deduction schedule.
However, when you later sell your house, you will be required to pay
tax on any depreciation you deducted on the home office schedule.  This
is called ‘depreciation recapture’, and it is taxed at capital gains
rates.   The other home office expenses are not subject to recapture
when you sell your house.

I hope these home office tax tips are helpful to you.  Remember, the
home office tax deduction could be one of your greatest tax
deductions.  There are many people who will tell you that the home
office tax deduction is a red flag.  Being self employed is a red flag
in itself, but you wouldn’t not have a business because it’s a red
flag, so you shouldn’t not take legitimate business deductions, such as
the home office tax deduction, just because you fear being audited.

Related Posts:

Why You Should Deduct Your Home Office
It’s Tax Season!  Are You Ready?

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• Why you should deduct your home office
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The home office deduction has been labeled as a red flag for years, but I think this deduction has too many benefits to just ignore it.

Robert Flach of The Flach Report agrees with me.  In his post "Three Cheers for the Home Office Deduction" Robert tells us why the home office deduction is great:

 1. It moves part of a deduction that would have been claimed on
Schedule A (real estate taxes and mortgage interest) to Schedule C and
as a result reduces your Adjusted Gross Income (AGI). While
a home office cannot generally be used to create a loss on Schedule C,
you can generate a net loss to the extent of the business use
percentage of real estate taxes and qualified mortgage interest. A home
office deduction in general will reduce your AGI, and reducing your AGI
can increase a whole laundry list of deductions and credits. See my
WANDERING TAX PRO post on “The Most Important Number on Your Tax Return”.

2. It reduces not only your federal and state income tax but also your self-employment tax. The home office deduction could provide 40% to 50% in total tax savings!

3. And, perhaps most important, it establishes your home as a place of
business for the purpose of deducting business mileage. You have no
“commuting”. Every time you leave your home to drive to another business location (a client, the office supply store, your business bank) you have deductible round-trip business mileage.

You no longer have to be afraid of claiming a home office
deduction. I do not believe that it raises the same “red flag” with the
IRS that it did in the 1980s and most of the 1990s. And you no longer have to pay tax on the business use percentage of the gain when you sell your residence.
All you have to do is “recapture” the depreciation claimed after May 6,
1997. Prior to 1997, if you had a $100,000 net gain on the sale of your
residence and you used 10% of the building as a deductible home office
you would have to pay tax on $10,000 plus the total amount of
depreciation claimed on the home office over the years.

 

Related Posts:

• Home Office Tax Tips
• Top 5 Missed Business Tax Deductions

This is a great question, so here goes…

1.  Automobile expenses – if you use your car for business, you can deduct a portion of your car expenses.  You can either keep track of and deduct your (business related) actual expenses, or you can keep track of your business miles and use the standard mileage rate (48.5 cents per mile in 2007).

2.  Startup expenses – business expenses incurred before you actually start the business used to have to be depreciated over 5 years.  Starting after October 22, 2004, you can now deduct up to $5,000 of startup expenses in the first year of business.  Startup expenses over $5,000 still have to be depreciated (over 15 years).  Startup expenses include advertising, hiring employees, purchasing equipment, supplies and more.

3.  Education expenses – you can deduct the cost of classes, seminars and other education costs if they are related to your current business.

4.  Travel – when you travel for business, you can deduct the cost of the airfare, taxis, hotel, meals, and other travel related expenses.  If part of your trip is for personal reasons, you may need to prorate part of the expenses.  Also, if you bring your family along, only your own expenses are deductible.

5.  Home office expense – many people choose not to take this deduction because it is considered a red flag.  If you have a legitimate home office, then you should not miss out on this deduction just because someone says it could be a red flag (being self employed is a red flag, but you wouldn’t not go into business because someone says you’re more likely to get audited as a small business owner, would you?).  Home office expenses include mortgage interest, real estate taxes, home owners insurance, utilities, and security alarm.  You can only deduct the portion that represents your home office, but this can be a substantial deduction for many home based business owners.

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