There are few tax deductions taken by business owners that are more feared than the dreaded home office deduction. Some tax experts are convinced that claiming this deduction increases the chances of an audit, while the IRS is adamant that this is not the case. Either way, if all the rules are followed, and records are properly documented, you should have nothing to fear.
Active owners of rental property may qualify for the home office deduction. The key to this deduction is the word active. The landlord must do more than just receive and deposit checks every month. You should regularly spend substantial time maintaining properties and preparing them for rent as well as seeking new tenants.
Once you have met this requirement you also have to meet the basic home office deduction thresholds. First of all, you have to use the home office exclusively for your rental business on a regular basis.
In addition, you must meet at least one of the following requirements:
1. Your home office is used as your principle place of business.
2. You have no other fixed location where you perform administrative and management activities.
3. You meet clients there.
4. You use a separate structure on your property for business.
After you have applied the threshold tests above and determined that the work area in your home does in fact qualify for the home office deduction, you need to look into what kind of expenses that can be written off. There are direct and indirect types. Direct expenses only benefit the home office area of the home such as painting or cleaning. Indirect expenses benefit the entire home and must be apportioned out between the home office area and the rest of the house. Mortgage interest, insurance, property taxes and utilities are examples of indirect expenses. Square footage is the usual method of determining the proportion of the home office in relation to the entire house to come up with a percentage. A 2,000 square foot house with a 200 square foot home office area would mean 10% of the indirect expenses could be written off as part of the home office deduction. You can also depreciate the house structure (not the value of the land) in the same percentage over 40 years. However, this may complicate matters when the house is sold.
Since you don’t want any trouble if you do get audited, you are going to want to keep good records to prove that you were entitled to take the deduction and that it has been accurately reported. You should document the home office space by a diagram and/or photograph that supports your square footage calculation. It is a good idea to use your home office address on business cards and other forms of communication and to have business mail delivered there. You should make an effort to meet clients at the home office and maintain a log to keep track of the client meetings and other time spent working there. Records to keep proving expenses include: property tax statements, utility bills, insurance premium notices, 1098 mortgage interest statements and receipts for any other home office expenses.
This topic can get quite complicated and the above is only intended to give you a basic understanding of the circumstances that would allow you to take advantage of the home office deduction.