(This is Part 7 of an eight-part series.)
If you are among the millions of homeowners and renters whooperate a profitable part-time or full-time business from your home, don’tforget to claim your home-business tax deductions to reduce your income taxes.It doesn’t matter if you are self-employed or you are an employee expected towork from home, such as an outside salesperson or a telemarketer.
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However, if your employer provides suitable workspace, butyou prefer working at home, then you don’t qualify for Uncle Sam’s generouswork-at-home tax deductions. For example, if you are a computer programmer whoprefers to work from home so you can supervise your pre-school child, you don’tqualify for home-business deductions if your employer provides suitable officeworkspace.
SELF-EMPLOYEDS MUST PASS THE PRIMARY BUSINESS LOCATION TEST. If youare self-employed, such as an independent contractor real estate sales broker,to qualify for the Internal Revenue Code 280A home-business tax deductions,your residence must be used either (1) to meet with clients, customers orpatients or (2) as your primary business location for administrative activityif you have no other fixed business location.
In 1999, Congress changed the tax law to allowself-employeds working from home to deduct business expenses if their residenceis their “primary business location.” Examples include aself-employed bookkeeper who travels to offices of her clients, a handyman whoworks at various job sites, and a computer repairman who works at many businessoffices during the week.
This tax law change was the result of the 1993 U.S. SupremeCourt decision denying anesthesiologist Dr. Nader Soliman (113 Sup.Ct. 701) anyhome-business tax deductions although he worked many hours at his condominiumreading professional medical journals and handling administrative details.Because he spent most of his work time at different hospitals, the court deniedhis home-business deductions. Today, however, he is entitled to deduct his homeoffice expenses because his condo is his primary business location.
WORK-AT-HOME EMPLOYEES HAVE A SPECIAL TEST. If youare a salaried employee working at home, the IRS imposes a special rule called”the convenience of the employer test.” You probably meet this testif your employer doesn’t provide suitable workspace, or expects you to workfrom home. Examples include outside salespeople, computer entry clerks andtelephone order takers.
PART-TIME BUSINESSES CAN QUALIFY. If youoperate a part-time business from your residence and you can meet the”primary business location” or “convenience of theemployer” tests above, then part of your home operating costs aretax-deductible.
To illustrate, suppose you operate a profitable part-timehome business selling books on the Internet about your passion, horse training.Or perhaps you sell Avon, Amway or Mary Kay products from your home where youhave an office and store inventory and supplies. Then you can qualify for thehome-business tax deduction.
But your home use must be a business, not a hobby orinvestment. For example, in the famous tax case of Joseph Moller (553 Fed.2d1071), he earned 98 percent of his income from his investment business. He wasa passive stock and bond investor operating from his living room. But the U.S.Court of Appeals denied Moller’s home-business deduction for investing which,the court said, was not a business.
However, the opposite result occurred in the U.S. Tax Courtdecision involving Dr. Edwin Curphey (73 T.C. 61). Dr. Curphey was a full-timedermatologist at a hospital. But he managed his rental properties on apart-time basis from his home office. The Tax Court ruled he was entitled toapplicable home-business deductions for his part-time property managementbusiness.
THE “EXCLUSIVE BUSINESS AREA” RULE. If yourfull-time or part-time home business meets the rules explained above, the nexttest requires an “exclusive business area,” which is not also usedfor personal or family purposes. But the exclusive business area need not be aseparate room.
Part of a room can qualify, but it cannot be shared use. Toillustrate, if you have your desk, filing cabinet and business supplies in onepart of the family room, that area can qualify. However, using your kitchentable to operate your part-time bookkeeping business, or occasionallyentertaining business clients in the living room clearly doesn’t qualify.
SQUARE FOOTAGE IS THE BASIS FOR HOME-BUSINESS DEDUCTIONS. Yourhome-business tax deductions are determined by the percentage of your home’ssquare footage that is used for the exclusive business area.
For example, suppose you own or rent a 1,500-square-foothouse or condo. One-third, or 500 square feet, is the “business area”where you keep your business supplies and have your office.
The result is 33 percent of applicable household expensesqualify as business tax deductions. If you are a renter, one-third of your rentis deductible on your business tax return. If you are a homeowner, one-third ofapplicable home expenses such as utilities, repairs, insurance, mortgageinterest and property taxes will be deductible on your business tax return, inthis example.
However, 100 percent of some expenses are fully deductible,such as your business telephone line (if you also have a personal telephoneline), business computer broadband fees, and painting or improvement costs forthe business area.
REMEMBER TO DEDUCT 100 PERCENT OF BUSINESS EQUIPMENT. If youpurchased business equipment and placed it in service in 2006, such as a newbusiness computer and software, 100 percent of that equipment cost isdeductible up to a maximum $108,000 deduction, with a maximum $25,000 deductionfor an SUV vehicle used in your business.
Higher equipment expense limits apply in an”enterprise zone” such as $208,000 in the Gulf Opportunity Zone.However, no deduction is available for personal assets converted to businessuse, such as a home computer bought in 2004 but converted to business use in2006.
DEPRECIATE YOUR HOME-BUSINESS AREA. If youown your house or condo, the exclusive business area is depreciable. Using theexample above, if your home-business area occupies 33 percent of your home’ssquare footage, then you can depreciate one-third of your residence’s costbasis (excluding nondepreciable land value) on a 39-year, commercial property,straight-line basis.
IRS Regulation 2002-142 says business use of your home won’taffect using the Internal Revenue Code 121 principal-residence-sale exclusionup to $250,000 ($500,000 for a married couple filing jointly). However, thetotal “business area” depreciation deducted must be”recaptured” and taxed when the home is sold using the special 25percent federal recapture tax rate.
HOME-BUSINESS USERS GET SPECIAL AUTO EXPENSE TAX BREAK. If youqualify for the home-business-use tax deduction, and you start your work dayfrom your home office, when you use your automobile or truck to visit customersor work locations, your business mileage becomes tax deductible the minute youdrive away from home.
For 2006, the business deduction is 44.5 cents per mile. Butyou must keep a daily log of business miles.
HOME-BUSINESS DEDUCTIONS CANNOT CREATE A TAX LOSS. However,home-business-expense deductions cannot create a tax loss.
That means your home-business deductions, when subtractedfrom your home-business profit, cannot create a tax loss against your otherordinary taxable income. But unused home-business losses can be carried forwardto future tax years.
To illustrate, if your business operating from your homeproduced a $2,500 profit in 2006, but your tax deductions for yourhome-business area are $3,200, only $2,500 can be deducted and the remaining$700 is carried over to a future tax year.
CONCLUSION: Whether you operate a full-timeor part-time business from your residence, and whether you are a homeowner or arenter, you can deduct applicable expenses to reduce your income taxes. Bothself-employeds and employees can qualify. For full details, please consult yourtax adviser.
SPECIAL REPORT AVAILABLE: Reprints of the entire”2007 Realty Tax Tips: Eight Chapters of Tax Savings for Homeowners andRealty Investors” are now available for $5 from Robert Bruss, 251 Park Road,Burlingame, CA 94010, or by credit card at 1-800-736-1736 or instant Internetdelivery at www.BobBruss.com.
Next week: the 10 most often overlooked realty tax breaks.
(For more information on Bob Bruss publications, visit his
Real Estate Center).
Copyright 2007 Inman News