Home office deductions

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	The new home office deduction Personal Finance Advisor by Deloitte & Touche OnLine January 18, 1999

The tax break has been expanded, but make sure you know the rules.

The Taxpayer Relief Act of 1997 included a modification of the IRS’s definition of "principal place of business" that will permit a larger number of taxpayers to qualify for the home-office deduction. For tax years beginning after 1998, the deduction will be available for home offices that are used for administrative or management activities related to the taxpayer’s business (for example, billing, maintaining records, ordering supplies, scheduling appointments, creating reports).

Principal Place of Business: Under the amended rules, a taxpayer is allowed to deduct expenses of a home office that is used for business purposes only if the space is used "exclusively" on a "regular basis" as

The principal place of business carried on by the taxpayer,
A place for meeting with clients or customers in the ordinary course of business, or
A place for the taxpayer to perform administrative or management activities associated with the business, provided there is no other fixed location from which the taxpayer conducts a substantial amount of such administrative or management activities.

The Taxpayer Relief Act of 1997 added this third provision to the definition of principal place of business.

The exclusive-use test will be satisfied if a specific portion of the taxpayer’s home is used solely for business purposes or inventory storage. The regular-basis test is satisfied if the space is used on a continuing basis for business purposes (that is, incidental business use will not qualify).

In determining the principal place of business (first provision under the definition of principal place of business, above), the IRS considers two factors: Does the taxpayer spend more business-related time in the home office than anywhere else? Are the most significant revenue-generating activities performed in the home office? Both of these factors must be considered when determining the principal place of business.

Employees: To qualify for the home-office deduction, an employee must satisfy two additional criteria -- the use of the home office must be for the convenience of the employer (for example, the employer does not provide a space for the employee to do his/her job), and the taxpayer does not rent all or part of the home to the employer. Employees who telecommute may be able to satisfy the requirements for the home-office deduction.

Expenses: Home office expenses are classified into three categories:

Direct Business Expenses relate only to the taxpayer’s business activity (for example, supplies, salaries). Expenditures for additional phone lines, long-distance calls, and optional phone services for the business may be deductible as direct business expenses. However, basic local telephone service charges (that is, monthly access charges) for the first line in the residence generally do not qualify for the deduction.
Permissible Expenses are expenditures that could be included as itemized deductions in the individual’s tax return (for example, mortgage interest, real estate taxes, casualty losses).
Previously Non-deductible Expenses would not be deductible if not for the home office deduction (for example, insurance, utilities, depreciation).

Limitation: Home office deductions are limited to the gross income from the business activity. Previously non-deductible expenses cannot create or increase a net loss from a business activity. However, a carryover to future years is available for unused, allowable home-office expenses. The following example illustrates the limitation and carryover.

Sale of Residence: Tax rules generally permit a $500,000 (married filing jointly) or $250,000 (single or married filing separately) exclusion on the gain from the sale of a primary residence. If part of the home is used for business purposes, the gain is divided into two parts -- personal-use portion (exclusion applies) and business-use portion (exclusion does not apply). For example, a taxpayer who qualifies for the exclusion, but has used 25 percent of the home for business purposes during the during past five years, will only be able to apply the exclusion against 75 percent of any gain recognized on the sale of the home.

These are some thoughts to consider about qualified domestic trusts. Your Deloitte & Touche financial advisors also can provide information and should be consulted before any action is taken.