Is it worth taking the Home Office Deduction?

Many taxpayers nowadays have home offices and often work from home. While it is relatively easy for self-employed individuals to qualify for the home office deduction, employees often have difficulties qualifying for it.

In order to qualify for the deduction and lower your tax liability, taxpayers must use part of their home (owned or rented):

- exclusively and regularly as the principal place of business

- exclusively and regularly as a place to meet or deal with patients, clients or customers in the normal course of the trade or business

If the taxpayer is an employee, the home office must also be for the convenience of the employer, not the employee. This is often the most difficult rule to meet.

To meet the exclusive use test, a taxpayer must have a specific part of the home (not necessarily an entire room) set aside and use it regularly and exclusively for the business. However, if the taxpayer uses this area also for personal use, even only occasionally, the home office deduction is denied.

Once you qualify for the deduction, you have to make sure you know which expenses are allowed and up to what amount. The home office deduction is limited to income from the home-based business, but any allowable expenses in excess may be carried forward to future years.

The order in which to apply the allowable expenses is as follows:

- mortgage interest, real estate taxes and qualifying casualty losses (or rent if property is rented)

- direct expenses such as repairs to business equipment and supplies

- insurance, utilities and general repairs

- depreciation

Any depreciation taken as part of the home office deduction will have to be recaptured upon the sale of the property, ie. in the year of sale it will become taxable income.

Self-employed individuals take their home office deduction on Schedule C for their business, however, employees will have to report the home office deduction on Schedule A (Itemized Deductions), where they are subject to a 2% floor of adjusted gross income. This makes the deduction much less valuable than it would be to a self-employed individual. Employees who don't already itemize their deductions will reap very little benefit if any from the home office deduction.

If you are in doubt whether you qualify for the deduction, please contact your CPA.