CAN YOU DEDUCT PART OF YOUR HOUSE? THERE’S NO PLACE LIKE A HOME OFFICE UNDER THE TAXPAYERS RELIEF ACT OF 1997

When Congress enacted the Taxpayers Relief Act of 1997, it may have provided more relief than it intended for people who toil in basements and other rooms that have been converted into home offices.

Indeed, the home-office deduction is now permissible even if a person’s home is not the place where most “business” actually takes place –

allowing potentially big savings for millions of Americans who don’t labor in traditional offices.

The old home-office rules were established in a 1993 U.S. Supreme Court ruling against an aggrieved anesthesiologist, Dr. Nader E. Soliman, who had applied for the home-office deduction but had been turned down by the Internal Revenue Service. Dr. Soliman had claimed the deduction because he was performing various administrative tasks at home and because the many hospitals he worked at did not provide office space. The court ruled that his home office was not his principal place of business and affirmed the IRS decision.

That highly restrictive ruling became the basis for all future home-office deduction standards – and made it virtually impossible for many individuals to deduct any home-office expenses.

But Congress last year made it easier for people using their homes as part of a business to qualify for a tax deduction.

Beginning in 1999, if a home office or portion of a home is used regularly and exclusively to conduct business, it can qualify for a deduction as the “principal place of business.” Claiming a home office is now permitted if the office is used for the administrative or management functions of a business and there is no other fixed location available to carry out these tasks.

As before, the area must be used exclusively for your business. You cannot use your dining room or den – it must be a separate area that is used only for business. Any other use rules out the area’s deductibility: If you have a television set in your home office and occasionally watch it, you fail to qualify for a home-office deduction.

everything old
is new again

Once your home office qualifies, a variety of expenses can be deducted: electric bills, heating and air conditioning costs, telephone expenses attributable to your business only, equipment depreciation costs and depreciation of the portion of your home used for a home office.

Determining how much depreciation to claim is best handled by determining the square footage of your home office as a percentage of your home’s total square footage and then applying that fraction to the amount of depreciation attributable to your home.

The deduction is now permissible even if a person’s home is not the principal place where business is conducted. For example, a consultant or a plumber who earns his or her income as a private contractor and visits clients at various work sites can qualify if the business is administered from the home. Employees are eligible, too, as long as their company does not provide them with any space to do their work.

Different types of home-office users will qualify under the new rules: a traveling salesperson storing inventory at home, a day-care operator, a surgeon with a bookkeeping office at home but whose principal place of business is the operating room. (Better late than never, Dr. Soliman.)

Now comes the good part.

A business owner may deduct travel expenses for trips from his or her business location to other locations for business reasons. On the other hand, the expense of commuting between one’s residence and one’s regular business location is not deductible. Since the latest law expands the definition of a home office, an important benefit of the new rule may be that home-office users can now deduct what were previously considered commuting expenses.

Why? Because when an individual’s home now becomes the principal place of business, costs incurred when traveling from home to other business locations may now be deductible. Such trips can include picking up supplies, meeting clients, dropping off packages at or delivering finished work. For some, these new kinds
of “travel expenses” may even exceed the value of the home-office deduction itself.

too good to be true?

A slight problem does exist concerning the new criteria. The new capital gains exemption on home sales must be adjusted after selling a house in which a home office is located and a home-office deduction taken. The percentage of the total home space allocated to the home office must be treated as a separate property when determining the capital gain.

To circumvent this problem, you must discontinue taking the home-office deduction in the year prior to the sale of your home. By doing so, you eliminate the need for separate capital gains calculations. If you did not but should have, no problem. Simply file an amended return.

Did Congress intend to permit those entitled to the home-office deduction to deduct their commuting expenses? That’s the $64 question. A strict reading of applicable law suggests that unless Congress chooses to act to plug this loophole, commuting expenses are now deductible by those who qualify for the home-office deduction.

Milton Zall is a registered investment adviser and certified internal auditor in Silver Spring, Md.