Understanding Home Business Deductions con't...

So You ARE A Home-Based Business

Assuming that a taxpayer’s activity is classified as a business and that the business has an office in the taxpayer’s home, additional criteria must be met before any deductions are allowed for the office.

A home office must be used exclusively and on a regular basis as the principal place of business by the taxpayer. If the area is used eight hours a day for business but children come in at night and play video games on the computer, the office fails the exclusive use test.

There are two exceptions to the exclusive use test. If the taxpayer is in the business of selling products, the area of the home that is used to store inventory does not have to meet the exclusive use test. The storage space must, however, be a specific, identifiable area.

The other exception applies when the home is used regularly to provide day-care services to children, handicapped persons, or the elderly. A formula based on the number of hours of business use and total use is applied to the allowable business deductions.

The term 'regular' use means that a specific area is used on a continuous basis. If used occasionally or incidentally, the use does not meet the threshold, even if the area is not used for any other purpose. Neither the courts nor the IRS has specifically stated how many hours per day (or per week) the office must be used for business purposes. The time element depends on the facts and circumstances of each individual case.

An office in the home is used as a principal place of business if it is a place used by patients, clients, or customers to meet with the taxpayer in the normal course of the taxpayer’s business. This use must be for the convenience of the employer, not the employee, if the taxpayer is employed outside the home. So, if you work for IBM and you use your home office to prepare for a sales call, your home office does not fit the criteria. That would be for your convenience, the employee, and not for the convenience of the employer.

Although a taxpayer may not regularly meet with customers or clients in the home, or perhaps the business consists mainly of selling or providing services outside the home, Congress recognized that almost every business needs a location where a business owner can store records, complete paperwork, and take care of other administrative tasks. Accordingly, the Taxpayer Relief Act of 1997 expanded the definition of the term “principal place of business” such that a deduction can be taken if the home office is used to conduct administrative or management activities, and the taxpayer has no other fixed location in which to do so.

That means that most self-employed people have to have someplace to work and that would be the home office. So you get the deduction. Additionally, a deduction is allowed for business expenses associated with the regular use of a separate structure that is not attached to the taxpayer’s home, such as an artist’s studio, a florist’s greenhouse, a mechanics garage, and a carpenter’s workshop.

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