Welcome To Kelan .Net

MAXIMIZING THE BENEFITS OF 'VIRTUAL' AT HOME

BUSINESS OFFICES

HOME  BUSINESS SOLUTIONS TAX SERVICES E COMMERCE FIRM PROFILE SECURITY LINKS

The general rule for the home office deduction is that a deduction is allowed to the extent allocable to a portion of the residence used exclusively and on a regular basis as a taxpayer's principal place of business for any trade or business of the taxpayer. The exclusive business use must be for the convenience of the employer and not simply for the benefit of the employee.

Home Office Expense Deduction

A taxpayer can deduct a portion of the dwelling unit, which is used exclusively on a regular basis

(A)  as the principal place of business for any trade or business of the taxpayer,

(B)   as a place of business which is used by patients, clients, or customers in meeting or dealing with the taxpayer in the normal course of his trade or business, or

(C)  in the case of a separate structure which is not attached to the dwelling unit, in  connection with the taxpayer's trade or business.

More self-employed taxpayers may now qualify for the home office deduction as a result of tax law changes enacted in the Taxpayer Relief Act of 1997. Prior to these changes, which became effective in 1999, a home office generally had to be the focal point of the revenue generating activity in order to satisfy the  "principal place of business" requirement. The home office deduction was not available if the taxpayer merely conducted administrative or management activities of the trade or business at home.

The revised rules changed IRC section 280A(c)(1), by expanding the term "principal place of business" to include "a place of business which is used by the taxpayer for the administrative or management activities of any trade or business of the taxpayer if there is no other fixed location of such trade or business where the taxpayer conducts substantial administrative or management activities of such trade or business."

A deduction, not subject to the percentage of AGI limitation, is permitted for an allocable portion of expenses such as real estate taxes, mortgage interest, home casualty losses, depreciation, homeowner's insurance, rent, home repairs, home security systems, utilities, and services.

Home Office Tax Planning Considerations

Although there are significant tax advantages of qualifying a portion of a principal residence as a home office, there are potential disadvantages that must be factored into your tax planning.

Increase in Audit Risk

Some suggest that claiming the home office deduction is a “RED FLAG” and may encourage the fine folks at the Internal Revenue Service to audit your return. If you qualify for the deduction and can benefit from it, you should take it. A home office properly run as a business with adequate records should be sustained upon audit and remember my favorite quote….  

“THERE IS NOTHING SINISTER IN ARRANGING ONE’S AFFAIRS AS TO KEEP TAXES AS LOW AS POSSIBLE... FOR NOBODY OWES ANY PUBLIC DUTY TO PAY MORE THAN THE LAW REQUIRES”

JUDGE LEARNED HAND, U.S. Circuit Court of Appeals Second Circuit

Sale of a Principal Residence Used As A Home Office

IRC section 121 provides for a exclusion on gain from the sale or exchange of a principal residence if during the five-year period ending on the date of the sale or exchange, such property has been owned and used by the taxpayer as the taxpayer's principal residence for periods aggregating two years or more and the taxpayer did not use the exclusion during the two-year period ending on the date of such sale or exchange.

Conversely, if a portion of the principal residence has been claimed as a home office in the two-year period prior to sale, the taxpayer must allocate the residence between personal use and business use. The personal use portion is a capital asset, eligible for the $250,000 exclusion under IRC section 121. The business use portion is considered an IRC section 1231 asset and is not eligible for gain exclusion. Any gain attributable to depreciation taken after May 6, 1997, is upon sale un-recaptured IRC section 1250 gain, taxed at a maximum rate of 25%, and any excess gain is section 1231 gain. If the sale of the principal residence results in a loss, the personal use portion is not deductible and the business use portion is a deductible IRC section 1231 loss.

A principal residence that has NOT been claimed as a home office in a two-years or more prior to sale can qualify that the entire property has having been used as the taxpayer's principal residence. No allocation between personal and business use is required. Any gain attributable to depreciation taken after May 6, 1997, is un-recaptured section 1250 gain, taxed at a maximum rate of 25%, and any excess gain is capital gain, eligible for the IRC section 121 exclusion. If the sale of the residence results in a loss, none of the loss is deductible.

If your principal residence is appreciating rapidly in value or you plan to sell your property within two years, be sure to mention this to your tax professional before claiming a home office deduction.

Taxable Loss Before Claiming The Home Office Deduction

If your home based business never shows a profit, claiming a home office deduction may be a moot point since the deduction cannot create a tax loss. Thus, claiming a home office deduction may not generate any significant tax benefits but may subject you possible taxable gain on the sale of your principal residence as noted above.

Effect On Contributions To SEP And Keogh Plans

Because the home office deduction expense (usually) reduces self-employment income this will impact the amount you will able to contribute toward to a SEP or Keogh plan.

BUSINESS SOLUTIONS TAX SERVICES E COMMERCE FIRM PROFILE SECURITY LINKS