To claim a rental deduction, you must use the portion of your home as the principal place of business activity conducted at home and as a place for meeting or dealing with clients in the ordinary course of your business. Your home office will qualify as your principal place of business if you spend most of your working time there and most of your business income is attributable to your activities there.
It must be regularly and exclusively used for this purpose.
The IRS uses their ‘theory of relativity’ when it comes to qualifying your home office deduction. They use 2 steps to determine whether a home office is the principal place of business:
- The importnace of activity at that location and
- The time spent at that location
A home office will meet the principal place of business test if it is used “exclusively” (there’s that word again) and regularly to conduct administrative or management activities and you can show that there is no other fixed location where you conduct substantial administrative or managerial activities for your business [J.K. Lasser’s Your Income Tax 2002 – This book is “our bible” and I and my accountant friends highly recommend it.]
The amount of your home office deduction must be directly proportionate to the total square footage of your home and cannot exceed gross income derived from the home office activity. If it exceeds this limit, the excess can be carried forward into the next year, if there is sufficient gross income in that year.
- Figure the square footage percentage.
1,500 total sq. ft./1 rm. is 10 X 11 (110 sq. ft.)
The room uses 8% of the total square footage.
This percentage then becomes the basis of indirect expenses you can also deduct: homeowners/renters insurance, security systems, repairs, maintenance, et cetera.
- Figure the home office deduction based on the percentage derived in Step 1. ($2,400 annual rent X 8% = Home Office Expense)
- Say you gross $30,000, and annual home office deduction is $2,400, you can deduct all of the home office deduction.
For tax purposes, business use of home is computed on IRS form 8829 and the deductible portion is recorded on the IRS Schedule C if you operate as a sole proprietor.
NOTE: If you are a homeowner you may not want to use the home office deduction. If you do, there will be a capital gain assessed on the percentage of the sale of the home. (The same percentage you used to calculate your home office deduction.) Please consult with your tax professional.