With new technologies and the increasing pressure of urban traffic, many people work from home nowadays. Virtual and/or freelance opportunities are becoming more attractive. People often ask me about the tax advantages of telecommuting. Both self-employed and salaried employees may qualify for home office tax deductions. However, home office deductions can often raise flags for the IRS if not done properly. There are quite a few things to consider.
The biggest mistake with home office deductions is NOT considering them. Many people forgo the benefit simply because they are afraid it will increase the risk of an audit. As a matter of fact, I have not found any audit statistics specifically tied to home office deductions and the notion is simply an urban myth.
The use of a place must be a principal place of business, or space to meet clients, or place to store inventory. (However, a plumber or a janitor who spends most of the time in various locations can still write off a home office if it’s used for administrative purposes and there is no other fixed office space)
The space does not have to be an entire room, but could be a specific area of a room. However the home office must be used exclusively and regularly for business purposes. So if you use a space 95% of the time for business and 5% for personal purposes (i.e.: my son does homework in my office occasionally), the space is disallowed as a home office.
If you are an employee, the home office must be maintained as a convenience to the employer. If you choose to work at home to avoid traffic and even if your employer provides you with adequate space at work, you are not allowed the deduction. Even if you do feel you qualify, I would recommend getting a letter from your employer stating that you must work from home for the convenience of the company and it was a condition of your employment.
If you are an employee, the home office is deducted as a miscellaneous itemized deduction subject to the 2 percent rule, meaning only your deductions over 2 percent of your adjusted gross income is deductible, so depending on your income, your home office expenses can be limited or not deductible at all.
If you are sole proprietor, home office deductions can be more substantial. They can offset your business income and also reduce self-employment taxes. Also, if you are a sole proprietor and have a home office, you can claim 100% of the mileage used for business, which means anytime you drive from home to clients, to the post office, bank, networking, etc., these miles can be deducted.
One last thing, when you sell your home with a home office attached, there is a 25% recapture tax on the depreciation deductions taken before. However, it’s always better to pay tax later than today if you can avoid it. And more often than not, the recapture tax you pay now (25%) is less than the taxes you saved. (your marginal tax rates usually are higher than 25%) There is also a simple way to avoid this if you are self employed: operate your business as an S Corp. Then you will avoid the potential tax trap if any.
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The articles are for general information only. In accordance with IRS Circular 230 they are not considered tax opinions for purposes of relying on such statements in any challenge of the reporting of the above transaction by the IRS. If a full tax opinion is required certain procedures must be met . Also there is a significant cost for a full tax opinion to meet the requirements of Circular 230.