Monday, April 28, 2008

The siren call of the Home Office Deduction...

As tax season approaches, prognosticators start to write on 'hidden' or 'secret' (or some other descriptive term) tax deductions, telling taxpayers not to 'miss out' on these 'tax saving' devices. One deduction which almost always seems to make the list is the infamous Home Office deduction.

In fact the myth of the missing home office deduction has become so prevelant that the House Committee on Small Business recently jumped on the bandwagon. But is it really a good idea? And does it deserve the hype it continually gets?


Now that's a daring comment, because most tax writers, and many tax practitioners would disagree with me. But hear me out.

First, The Rules:

In order to deduct a home office, you must observe some rules, which the House Committee recently called 'inordinately complex'. Here they are, courtesy of IRS Publication 587 and their 'tax tips':
  1. The 'office' area must be exclusively used as a home office. This is the sticking point for a lot of people. Frequently, people will convert a portion of a larger room (say, a den) to an 'office' area, and wonder if they can claim a home office. The quick answer? No. The key here is the phrase 'separately identifiable space'. If all you've done is stick a desk in the corner, it's not enough to qualify for a home office deduction.
  2. The area must be the principal place of business for your business. Ok, so it sounds wordy. But it's actually pretty straightforward, because all you have to do is answer one simple question: When someone at a cocktail party asks you where your office is, what do you say? If you say "I have an office at my home," then your home office is most likely your 'principal place of business'. But if you say "I'm in the Smith-Jones building" and never mention the home office, then your home office fails this test. It's that simple.
  3. The area must be the place in your home where you regularly meet with or deal with patients, clients, or customers only. Again, pretty straightforward if you think about it. Say Suzie Client comes over. You show her into the office in the back. So far so good. But then Bill Buddy comes over, and he stops there as well. Now you might have a problem. If Bill comes there because you're there, and the two of you immediately repair to the den, it's not as much of a problem as if you and Bill hang out drinking for a few hours. At that point, you've probably blown the deduction (though a one-time event isn't as bad as doing that every Saturday).
  4. The area must be used for a trade or business. This one almost seems to belong in the 'huh?' category - as in 'can it be more obvious?' After all, this is a home office we're talking about. But realize that this little provision means that you can't claim a home office for using that third bedroom to do your stock trades unless you are a legitimate trader.
That's it. Sure, you have to calculate just how much of your home is an office, but by comparison, that's pretty straightforward. If you can meet the requirements above, you're eligible to claim a home office deduction, which means deducting part of your mortgage/rent, utilities and other expenses. Even better, it means that you just might be able to write off more of the mileage on your new Hummer.

But the real question here is: Do you want to?

Tomorrow: Why taking the home office deduction is a bad idea.