- What is a "Business," for the Purposes of the IRS?
In
general, to be eligible for home business deductions you must be engaged in an
activity with the intent of making a profit. It's presumed you meet this
requirement if your business shows a profit in any two years of a five-year
period.
- When Can You Deduct Your Home-Related Business
Expenses?
To be eligible for business related deductions,
generally, the Internal Revenue Service requires that you use the part of your
home claimed as a deduction "exclusively and regularly" as either the
principal location of your business or the place reserved to meet patients,
clients, or customers. Thus, if you work out of the corner of the den, but the
family also uses the room for watching television, you cannot deduct the space
as a business expense. Your personal telephone, if used for anything other
than business calls, is not a legitimate deduction (although the
business-related phone calls are deductible). Carefully review the tax laws
before filing for any home business deductions.
However, if you are
looking to deduct costs that would otherwise be personal in nature ... such as
the a portion of your apartment rent, depreciation on part of your residence,
or utilities prorated to the home office ... there are several rather strict
rules that come into play. In brief, not only must the use of the home be an "ordinary and necessary" expense for your business, but it must qualify as the
"principal place of business" under IRS regulations. Under current guidance,
your "principal place of business" is ANY one of these:
- The place where you regularly meet with customers or clients in the
normal course of your business; or
- The place where the "income producing" activity most often takes place
(you measure the percentage of actual income producing activity time spent
vs. the back-office type of activity). (If the income producing activity
takes place at several locations, including the home office ... you
generally would consider the average amount of time you spend in the home
office by comparison to all other places. Note: Only time YOU spend in the
office counts. Don't count office time put in by assistants or employees.) ;
Or
- The office is a separate structure from the home, and you do not
calculate the expenses as a percentage or portion of your home expenses.
There are a couple of exceptions to note within the "exclusive use" tax rule.
- One is the storage of inventory in your home. If you use your home as
headquarters for a trade or business in which you sell retail or wholesale
products, and use a separately identifiable space to store inventory
regularly, you may be able to legitimately deduct use of the area used to
store inventory.
- Two is the use, subject to stringent conditions, of your home as a
daycare facility providing care for children, the elderly, or the physically
or mentally disabled. While not restricted by "exclusive use" regulations,
use of the home can only be considered deductible if you comply with all
applicable state laws and regulations for the licensing of such
institutions. This is a very hard deduction to qualify for, given the
licensing and regulatory requirements for this heavily regulated industry.
- What Portion of the Home Is Deductible?
Assuming you
otherwise qualify, the IRS is going to treat the part of your home you use for
business as though it were a separate piece of property. This means that
you'll have to keep good records and take care not to mix business and
personal matters. You can begin by calculating what percentage of the house is
used for business, either by number of rooms or by square footage. Thus, if
you use one of five rooms for your business, the business portion is 20
percent. If you run your business out of a room that's 10 by 12 feet and the
total area of your home is 1,200 square feet, the business space factor is 10
percent. Daycare facilities require a different calculation. If you're a
renter, you can deduct the portion of your rent, which is attributable to the
business share of your house or apartment. Homeowners can take a deduction
based on the depreciation of the business portion of their
house.
- What Are the Limits of Home Business
Deductions?
There is a limit to the amount of business expense
you can deduct from your federal income tax. This is equal to the amount of
gross income generated by the business minus those home expenses you could
deduct even if you weren't operating a business. For example, real estate
taxes and mortgage interest are deductible regardless of any business activity
in your home, so you must subtract from your business' gross income the
percentage that's allowable to the business portion of your home. You thus
arrive at the maximum amount for home-related business deductions. Even though
the deduction for business use of the home cannot exceed the net income from
the business, or for an employee, it cannot exceed wages paid by that
employer, any excess expenses can be carried forward to offset future business
income.
- If You're Not a Separate Business Entity (like a corporation) How Do
Your Report Home Business Income/Loss?
If you are a sole
proprietorship (running the business under your own name (or a trade name
registered to you for this purpose) you are deemed to be "self-employed," and
should claim your business deductions on Schedule C, Profit (or Loss) for
Business or Profession in your annual federal income tax return. If a
self-employed person is entitled to claim expenses for business use of his
/her home, Form 8829 must be completed and attached to the tax return. Because
of the IRS's extra scrutiny of these kinds of returns, it is always wise to
keep meticulous and detailed records if you claim business related expense.
