Residential Real EstateTrim Your Tax Bill With Home Office Deductions
Despite all the recent tax cuts, most homeowners are continually looking for another way to reduce their tax bills. If you operate a home-based business, you may be able to do that through deductions for a home office.
There are just a few days left to file your taxes (unless you file an extension for the August 15 deadline). The Internal Revenue Service’s Web site, www.IRS.gov, has a many publications, forms and instructions you’ll need to deduct expenses for your home office, if it qualifies.
The premiere booklet you’ll need available at the IRS Web site is “Publication 587 - Business Use of Your Home (Including Use By Day Care Providers).” As it sounds, this publication (online) will give you the limitations and nuances of the home office deduction.
First of all, you’ll need to define whether or not your home office qualifies for a deduction.
To qualify to claim expenses for business use of your home, you must meet the following tests:
1 - Your use of the business part of your home must be:
Exclusive
Regular
For your business, AND
2 - The business part of your home must be ONE of the following:
Your principal place of business
A place where you meet or deal with patients, clients, or customers in the normal course of your business, or
A separate structure (not attached to your home) you use in connection with your business.
I’m not going to define “exclusive, regular and for your business,” here. You can do that with the online publications. However, let’s run through an example of how a homeowner who uses his house in his business could deduct those expenses from that office.
The taxpayer must understand there are limits to this deduction. If the deductions are less than the gross income from the business use of your home, you can deduct all your business expenses related to the use of your home. If your gross income from the business use is less than your total business expenses, your deduction for certain expenses for the business use of your home is limited.
Expenses for a home office are reported on “Form 8829, Expenses for Business Use of Your Home.” This form will walk you through several calculations for:
Part of your home used for business
Figure your allowable deduction
Depreciation of your home
Carryover of unallowed expenses to 2002
In the world of expenses, you have direct expenses and indirect expenses for the home office. A direct expense would be if you had to paint or install carpet for that office space. An indirect expense would be mortgage interest, real estate taxes, insurance, repairs and maintenance, and utilities.
If your house takes up 10 percent of the space of your total house, that is the limit you’ll have for the indirect expenses. For example, if you bring in $25,000 in your business and your indirect expenses total $3,600, you’ll get to deduct $360 from your $25,000 income. If you paid $300 to have the office painted, however, that is a direct expense and would be fully deductible.
The entries on your Form 8829 might look like this:
I - Part of your home used for business
Area of home office:200
Area of whole house: 2,000
Percentage of home office: 10%
II - Figure your allowable deduction Indirect Expenses
Deductible mortgage interest $4,500
Real estate taxes$1,000
Insurance: $400
Repairs & Maintenance:$1,400
Utilities:$1,800
Total:$9,100
Times % of home office:10%
Subtotal Deduction:$910
Direct Expenses
Repairs & maintenance$300
Subtotal Deduction: $300
TOTAL DEDUCTION$1,210
III - Depreciation of your home
Smaller of home’s adjusted basis or fair market value:$130,000
Value of land included in above figure: $20,000
Basis of building:$110,000
Business basis of building (x10%)$11,000
Depreciation percentage. x 2.461%
Depreciation allowed:$271
When you add up all the appropriate lines calculated above, you would have a $1,481 deduction off the income from this home-based business. However, if after the depreciation you were at a loss instead of a positive income, your deduction would be limited (of course, see instructions from www.irs.gov or Publication 587).
If you decide to use these deductions in your business, keep in mind there’s always a string attached. As you deduct and depreciate these expenses to reduce your tax bill, at the time you sell your house, that portion of your capital gain exclusion will be reduced by that area of your house. In other words, since you’re not paying taxes on it now, you will later. Be sure to talk to a professional to determine if this deduction is worth your time and money.
Finally, renters can also take many of these deductions for operating a home–based business. Read, read, read and then check with a professional to be sure you get all the deductions you’re allowed.
DISCLAIMER: I am not a tax professional. This column is meant only as an instructional tool, pointing you toward the professionals and resources you should use to determine if your home office can be a legal deduction against your personal income. Seek out professional assistance on whether you can use the information in this column for your personal situation.