LOISELLE, GOODWIN & HINDS
CERTIFIED PUBLIC ACCOUNTANTS

Home Office Deductions for the Self-Employed Taxpayer

If you're self-employed and work out of an office in your home, you should know about the strict rules that govern whether you can deduct your home office expenses.

You may deduct your home office expenses if you meet any of the three tests described below: the separate structure test, the place for meeting patients, clients or customers test, or the principal place of business test. You may also deduct the expenses of certain storage space if you qualify under the rules described further below.

If you do qualify, you compute your home office deductions on form 8829, and report them above-the-line on Schedule C.

Separate structures. The easiest test allows a deduction for the costs of a separate unattached structure on the same property as your home -- for example, an unattached garage, artist's studio, or workshop -- that is used as a home office. To qualify for the deduction, the separate structure must be used exclusively and regularly in connection with your business.

Home office used for meeting patients, clients, or customers. Alternatively, you may deduct home office expenses if you use the home office exclusively and regularly to meet or deal with patients, clients, or customers in the normal course of your business. You have to meet with patients, clients or customers in the home office -- telephone calls to them from your home office won't do the trick.

Principal place of business. In addition, you may deduct home office expenses if you use your home office, exclusively and regularly as a principal place of business, that is, as the main location of a business that you operate. If your home is the sole location of your business, and you supply services (or sell goods) from that location, then you automatically meet the principal place of business test. However, if your business has several locations, or you perform some business functions inside and outside of your home, determining where your principal place of business is located can be difficult.

In 1993, the Supreme Court declared that to determine a taxpayer's principal place of business, you must look at:

1. The relative importance of the activities performed at each location where the business was conducted, and
2. The amount of time spent at each place.

Business people or professionals who manage their business from a home office, but provide goods or services outside the home, cannot satisfy this test. The Supreme Court holding denied home office deductions to many individuals, such as doctors who work at a clinic but do their paperwork at home, salespeople who use their home office as a base but sell outside the home, and owners of retail establishments or tradespeople who do their business paperwork at home. Fortunately, relief is on the way. Under a change made by the Taxpayer Relief Act of 1997 and scheduled to go into effect in 1999, all the above types of business people and professionals will regain the right to their home office deductions. Beginning in 1999, a home office will qualify as a principal place of business if a business person or professional uses it to conduct administrative or management activities of the business or practice, as long as there's no other fixed location where he or she conducts substantial administrative or management activities of the business or practice.

Space for storing inventory or product samples. If you're in the business of selling products at retail or wholesale, and if your home is your sole fixed business location, you can deduct home expenses allocable to space that you use regularly to store inventory or product samples. The space doesn't have to be used exclusively for business purposes. And you can do business at the fixed locations of your customers (e.g., retail stores, if you're a wholesaler), and non-fixed locations, such as flea markets or craft shows.

What you get if you qualify for home office deductions. If your use of a home office qualifies under any of the conditions we've outlined above, you may take business expense deductions for:

• ...the direct expenses of the home office, such as the costs of painting or repairing the home office; and
• ...the indirect expenses of maintaining the home office, such as part of the utility costs, depreciation, insurance, etc., for your home, as well as part of your mortgage interest, real estate taxes, and casualty losses.

However, the amount you may deduct as home office expenses is subject to an overall limitation. Your deduction for direct and indirect home office expenses can't exceed the income from your business use of the home office, less:

1. Your residence-based deductions that aren't dependent on use of your home for business (e.g., mortgage interest and real estate taxes), and
2. Your business deductions that aren't attributable to your use of the home office (such as office supplies, salary, postage, etc.).

If you're getting the idea that home office deductions aren't a do-it-yourself proposition, you're right. The rules are quite complex, but they can be rewarding for those who know how to apply them properly. We can put you on the right track quickly and efficiently, and also explain how claiming home office deductions affects other tax breaks, such as deductions for traveling from your home to other business location, and the $250,000/$500,000 exclusion for gain on the sale of principal residences. Please contact us if you would like to discuss these matters.

(08/20/98)

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Last modified: July 09, 1999