Home-office tax fallacies

In 25 years of preparing tax returns for home-based workers, Jan Zobel can count on one thing: Clients will always come armed with misperceptions of how the IRS treats the home office.

The tax agency is out to get the home worker, they lament. Agents flag returns with the attached Schedule C for itemizing home-office deductions, assuming the claim isn’t legitimate.

People assume the IRS sees the home-office deduction as a cover for abuses, says Zobel, an IRS-licensed tax preparer in Oakland, Calif., and author of “Minding Her Own Business: The Self-Employed Woman’s Guide to Taxes and Recordkeeping.”

The deduction is sometimes abused because it can save you a lot of money. Say you have a 1,500-square-foot home with a 150-square-foot office. Because the office is 10% of the home’s total space, you can deduct 10% of the year’s mortgage interest and taxes (or rent payments), insurance and other utilities. You can also deduct the square footage of a workspace that’s not a dedicated room, such as a corner of the den or bedroom. Even better, office furniture, equipment, business telephone and fax/data lines, and the business calls made on them, are often fully deductible.

Ready to take the deduction? Consider these common misperceptions first:

* “It’s OK if my in-laws stay in the home-office-turned-guest-room one week per year.” To qualify for the deduction, the space must be used “regularly and exclusively” as a home office, not as a guestroom or after-hours playroom. And the computer paid for and deducted by the worker can’t be used by the kids or for personal matters.

* “Teleworkers can’t deduct the home office.” The rule for teleworkers is pretty clear-cut. If you telework for the convenience of your employer (e.g., the company has no suitable office space for you or you work in a region where no corporate office exists), then you can deduct the home office. But if you telework for your convenience, say, to eliminate a commute or achieve work-life balance, you can’t.

* “No harm in skipping the depreciation deduction.” Depreciation is the process of a home owner deducting the business use of the home over a period of years – as you might with a piece of equipment. Yet home owners who claim the home office but decide not to depreciate the space while using it are still responsible for taxes on capital gains when they sell the house.

In a separate tax issue, the IRS in December 2002 changed how it views the home office when a home is sold. Formerly, home offices were not considered part of the personal residence, and were subject to capital gains taxes on profits from a home’s sale. Now, home offices and personal residence alike are excluded from taxes on profits of up to $250,000 (if single) or $500,000 (if married). Better, the new law is retroactive, so if at some point you sold a house but didn’t claim the home office, you can now amend several years’ returns and get a refund for excess taxes paid.

Next time, more considerations for deducting a home office.