Can You Deduct Your Home Office?

If you are planning to finance your new home office in part by tax deductions, you had better know the rules.

IRS

The IRS was once pretty stingy with home office deductions. Very stringent rules had to be met to deduct the office at all. Starting with tax year 1999, however, the home-office deduction requirements are more relaxed.

If your home office qualifies, you can depreciate the cost of building your home office and deduct a percentage of the cost of many home-related expenses. These expenses typically include utilities, rent, insurance, mortgage interest, real estate taxes, and some casualty losses, repairs, and improvements (if they relate to the part of the house you use for business).

According to the on-line Nolo Law Center, to qualify your home office must meet two basic tests:

Regular and Exclusive Business Use: You must regularly use your office exclusively for a trade or business. Regular means business use on a continuing basis -- not just for occasional or incidental use. A few hours a day on most days is probably enough. Exclusive use means that you use a portion of your home only for business. If you use a room of your home for your business and also for personal purposes, you don't meet the exclusive use test.

Other Tests: In addition to regular and exclusive business use, you must be able to show any one of the following is true:

Your home office is your principal place of business: If your home office is your only place of business, you pass. If you have another business location, your home office must be your principal place, which it is if both of these are true:

        1. You conduct the administrative or management activities of your business at your home office, and...

        2. You have no other fixed location where you conduct those activities.

Your home office does not have to be the place where you generate most of your business income. It's enough that you regularly use it to do bookkeeping, scheduling, research, or ordering supplies and you have no other fixed location where you do such things.

You meet clients in your home office : If your home office isn't your principal place of business but you regularly meet with clients there, then you can take the deduction.

Your office is a separate structure: You can deduct expenses for a separate, freestanding structure that you use regularly and exclusively for your business. But be sure you use the structure only for your business: You can't store garden supplies there or use it as a guest house.

Required by Your Employer: Employees have still one more test to pass. Home office space is not deductible for you unless it is required by your employer. If the office is not an employer requirement, but only for your convenience, then it is not deductible no matter how much work you do there. At minimum get a letter from your employer stating that you must maintain a home office as a condition of employment and detailing what functions the home office is to be used for.

Self-employed taxpayers have more to gain from a home-office deduction than employees. Employee expenses are subject to a 2% of Adjusted Gross Income floor. This means you can deduct only those expenses above 2% of your adjusted gross income. The self-employed have no such restriction, but do have one that applies only to you. The home-office deduction cannot exceed the net income of your business. In other words, you cannot use the home-office deduction to generate a business loss, but you can carry any unused home-office expense to future tax years where it can be used to offset income in those years.

Obviously good record keeping and documentation are very important. Here are some steps you can take to help establish your legal right to deduct home-office expenses.

• Photograph your home office and draw a diagram showing the location of the office in your home. Keep this information in your tax folder.

• Have your business mail sent to your home.

• Use your home address on your business cards and stationery and in all business ads.

• Get a separate phone line for the business.

• Meet clients or customers at your home office -- and keep a log of those visits.

• Keep track of the time you spend working at home.

This article is not intended to be either legal or tax advice. To determine whether your particular office is a deductible expense and which expenses are deductible, consult a qualified tax attorney or accountant.

An Office in Your Home
Home office design sketch . If you have a computer in your home, you probably have a home office. It may be very basic: a computer and printer on a folding table, some old grocery cartons for filing. You may not need anything more than this. In fact, if this works well for you, stop reading. There is nothing in the rest of this article that will interest you at all.

If your needs are a little more demanding, then you might consider upgrading your existing arrangement. How much home office you need depends on what you do with it.

We can identify four basic types of home office which may be mixed and matched and combined in any number of ways.

Work office: If you work at home, either for your employer or because you are self-employed, you will often need a very functional office with lots of computer capabilities, broadband connectivity and ample storage for papers and files. If clients visit you in your office, a separate entrance is often a necessity — and some zoning regulations require it (others prohibit it — Ah, the zany world of zoning.)

Household management office: This is the household administration, bill-paying and investment management center. It usually needs reasonable computer capability and connectivity and some storage for household records.

Homework center: There may be one of these shared by all children or one for each child. It is not uncommon today to see a small homework center in each child's bedroom.

Kitchen planning area: This is actually a variation on the management office, but this office is devoted to meal preparation planning, grocery shopping and recipe storage.

Over 50 million Americans currently work at least part time from their homes, and millions more have created work stations for paying bills, tracking finances and investment finances and investments, pursuing hobbies, and e-mailing family and friends. Homework centers with considerable computer power are becoming more common as they become more necessary. Many school programs now assume a child has access to a home computer.

Planning for a Home Office
Most of our homes were not designed with a home office in mind. Even today, except in very up-scale housing, it is unusual to see a space specifically set aside as office space. The typical plan shows one room labeled "Guest Room/Office", but a close examination of the plan shows no special provisions for office space such as heavied-up electrical service — it's just a label.

Finding Space
So, if we decide on a home office, it's typically a matter of scratching out some space in another room — a corner of the room, space underneath a stairway, or a little-used closet (is there such a thing?) can be converted to compact workspace. In a pinch, a computer armoire that opens to reveal a home office, and closes to hide it out of sight behind attractive cabinet doors can be turn a corner of any room into a very compact office. If you have study, den or unused bedroom, then the space problem is easier, but not completely solved because these rooms are usually not configured as offices and need to be adapted.

Photo: AristoKraft Cabinetry A neat, compact office under the stairs. Photo courtesy AristoKraft A neat, compact office under the stairs built using Aristokraft cabinets. With careful planning you may even be able to borrow temporary space for your home office. For example, a small office tucked into a corner of the dining room may allow you to use the dining room table as additional working surface during the day, and back to a dining table in the evening. In a kitchen, the kitchen countertops may be used the same way.

The Minimum Home Office
Fortunately, home office spaces do not have to be big to be workable. Thanks to the personal computer, it's possible to create an effective work center in just a few square feet. The minimum work surface should be 60" wide and 30-32" inches deep: about the size of a typical office desk. You will need ten square feet of uninterrupted floor space in front of the desk to get you in and out of your chair. If you plan for filing cabinets, you will need 3' of drawer pullout space in front of the cabinets. You will need ample electrical power. You may want to install receptacles at desk level so you don't have to route power cords around your work surface or have a tangle of cords at your feet.

Photo: Wellborn Cabinets, Inc. Wall cabinets over the work surface provide accessible storage for supplies Lighted wall cabinets over the work surface provide accessible storage for supplies. This elegant office assembled from Wellborn cabinets. Use the wall space above your main work surface for shelves or better yet, cabinets that hold supplies and reference materials and the space below it for filing. If you want separation between your work area and the rest of the house, consider a folding screen, a freestanding bookshelf, or even big potted plants -- all of which can make attractive visual barriers.

The "Circle of Reach" Rule
In planning a home office, always keep in mind the "circle of reach" rule: Put all materials and equipment that are immediately necessary to your work needs within easy reach of your work chair. Find nearby locations for other materials and equipment you need less often.

Making the Most of Compact Workspace
If workspace is tight, there are a few tricks to getting more out of it.

A few years ago a frequent recommendation was to use a laptop rather than a desktop computer to save desk space. That was primarily because a laptop, though less powerful than a typical desktop computer, was not tied to a giant video monitor. With the advent of reasonably priced flat screen monitors, that concern has largely gone away. However, if you need both a laptop and a desktop, consider a laptop and a docking station instead.

Free up some valuable desk space by installing a wall-mounted telephone.

Put your keyboard in a slide-out tray under the desk surface. This is a better height for a keyboard, and gets it off the desktop. When not in use, just push it closed.

Consider rollaway file cabinets. When you are working with the contents of a cabinet, pull it up to the desk. When you are done, park it back where it came from — even in another room if that's the space you have for file storage.

You can also locate office machines (printers, faxes, copy machines) in another room. The is common in commercial offices where these machines are often shared among several users. Cable routing may require professional help, but if you have a crawlspace or basement beneath, or an attic over your office space, cabling is not typically a major problem. Or just go wireless and avoid the problem altogether.

Other Features to Think About
Some other things to consider in planning your home office are its ties to the rest of the house and the rest of the world.

Phone lines: How many do you need? The computer, fax machine and handset all need to be connect to the telephone. Is one line going to be enough? Most employment-related home office need separate lines for each. However, if the fax is not critical to your work, a line shared by the fax and handset is a workable compromise. Also, if you have DSL service, all of these machines and your conversations may be able to share the one DSL line. Ask your local telephone provider.

Office Telephone Electrical service: How much power will you need in the room, and will you need an extra circuit? All of the typical office machines need power, some need a lot of power — your laser printer, for example. You will almost always need at least one extra circuit, so while you are at it, make it a heavy-duty 20 amp. circuit connected to an uninterruptible power supply (UPS) located next to the service panel. That way loss of power won't destroy the last four hours of work you have not saved yet, and the bulky UPS box is not underfoot.

Separate entrance: If your office is where you do your work and meet clients, unless you want them tramping in and out of your living areas, consider a separate entrance. If there is a window in the proposed office space that is at least 32" wide, a separate entrance is fairly easy to construct. Be careful about local zoning requirements, however. In some places such an entrance in a residential area is prohibited. But if allowed, a separate entrance makes a stronger case to the IRS for the tax deductibility of your home office (See the sidebar at right).

Heating and Air Conditioning: If the only room in your house used during the day is your office, why heat or cool the rest of the house too? Separate heating, cooling and ventilation for your office may be an investment that pays off in utility savings in a very short time. It also helps keep the odors of cooking cabbage out of your office on kielbasa night.

Privacy: Do you need privacy for your work, or do you need to keep an eye on the kids at the same time? Such factors as these determine how the office relates to the rest of the house; or how much electronic monitoring we install.

Wired or Wireless: A full-scale business home office used to require a lot of wiring for computers, Internet connections, and a local area network. Wired connections are no longer required now that low-cost reliable wireless systems are everywhere on the market. Our recommendation today is usually to go wireless unless the category 5 wiring already exists.

NetWorking: Not just for big commercial offices any longer, home networking that allows several computers to share peripheral devices such as a printer, scanner and high-speed Internet connection is almost required in a home with two or more computers. Typically the cost of a wireless network is quite a bit less than equipping each computer with the required peripheral equipment, and much more flexible. The ability to share hard-disk space means that essential business, financial and investment records can be safely backed up to another computer in case your main office system dies. (This has been known to happen — seriously.) Special software can also be used to monitor what the children are looking at on their computer. This isn't spying, it's exercising parental guidance. OK, it is spying, but that's what we're supposed to do. It may also be a good idea to keep track of what they're printing on the one main network printer.

Costs of a Home Office
Photo: Restoration Hardware Computer armoire Closed, this armoire is an elegant piece of furniture. Open it's a fully functioning micro office. Available from Restoration Hardware. If all you need is a table and chair, you can set up a home office for a few hundred dollars (plus the cost of your computer system). But if you build a home office with typical custom furnishings or even customized modular units, expect to pay $5,000 and more in this area. According to Remodeling Magazine, an industry trade publication that keeps track of such things, the average home office in 2002 cost $10,526.

Worse news is, however, that you are not likely to recoup all of this cost if you sell your house. Only about 55% of the cost comes back to you on sale. If you think about it, what is the likelihood the new buyer is going to need an office? If he doesn’t, he's not going to pay much for one. Of course, if the office is exactly what attracted him to the house in the first place, then it has paid for itself. In some areas, according to Remodeling Magazine, an existing home office is a "big selling point." But generally, if you are going to build a home office, do it only if you plan to be in your home for quite a while. We hate to lose your business, but there it is.

Furnishing Your Home Office
No matter how small or large your home office , certain furnishings are essential. At minimum a desk, a chair, and some file storage.

The Work Surface
Office desk The most important part of your home office is the work surface. It should be at a minimum 60" wide and 30" deep. Not surprisingly, that is the dimension of the most common office desk. A little wider is better, but beyond 72" items on the surface are outside most people's circle of reach. Deeper is not necessarily better. Beyond about 36" items are out of reach, but if you are using a CRT monitor or printer on your work surface, then a slightly deeper surface will put these items out of the way, behind the writing area at the front of the surface.

A desk of some sort is the most common work surface. It has the advantage of being already done. All the usual facilities you need are built in — drawers, for example. Another common way of making a work surface is to span two base cabinets with a countertop. Typically good base cabinets cost less than a quality desk, so this is a good way of stepping up quality without stepping up cost. And you can get the features you want in customizable base cabinet modules rather than the features the deskmakers think you need.

Many desks come with some sort of filing drawer. In most home offices, this is not nearly enough filing space. Our advice is to forgo the filing drawer in favor of a computer or printer shelf — someplace to stash the computer where it won't crowd your knee space — and use a mobile file cart to hold files you are immediately using. It can be parked out of the way when not needed. Photo: Herman Miller. The Aeron Office Chair A comfortable chair that is fully adjustable and provides good lumber support is essential. The Aeron Chair from Herman Miller has become an office icon.

If you think the idea of an office in a box is new...

The Wooten patented "Cabinet Office Secretary" was manufactured in a number of styles and with more or less Victorian Wooton Desk elaboration by William S. Wooton for nearly 40 years from 1870 to 1907. The design of the desk provided an ingenious solution to the 19th century businessman's increasing problems of organization. It was advertised as combining "neatness, system and order," with "every particle of space practically utilized." With its 56 drawers and nearly as many slots and pigeon holes, the cabinet secretary was a smashing success — despite its hefty price tag (for the time) of $325.00 and up depending on decoration. Wooton Desk

Even today, the Smithsonian Institution still uses its Wooton Patent Secretary, purchased new in 1876 - over one hundred and thirty years of continuous use.These beautiful, intricate, handcrafted cases now sell for well over $15,000 for a desk in good condition.

Absolutely no place for a computer, though. A Comfortable Chair
The value of a comfortable chair cannot be overstressed. One can be acquired at most office supply stores — Office Depot, Office Max — for under $300.00. It is well worth the investment. You do not want a task chair, but an executive chair with tilt and swivel capability. Being able to lean back and put your feet up every once in a while cannot be overvalued as a very necessary home office function.

File Storage
A large four-drawer file cabinet is a must for most home offices. If yours is an office for working at home, several file cabinets are going to be necessary. Filing is a tiered storage process. The first tier is those files you are Office credenza Our well-organized credenza keeps files and supplies within the "circle of reach". This quartersawn oak unit is built in the Craftsman style. using now. These go in a mobile cart within the circle of reach. Next in the hierarchy are "current files", not in use at this moment, but that probably will be used sometime soon. These are in the secondary file storage in cabinets inside or near the home office. Finally there are closed or archived files — last year's tax records, for example. These need to be kept for a few years, but should be relegated to box storage in the basement or attic. This is what office management experts call "tertiary" storage.

Other Storage
Beyond file cabinets for document storage, any home office is going to need storage for office supplies: pens, computer paper, folders, envelopes in various sizes, catalogs and other reference materials. Here is where a good set of wall cabinets comes into its own. Installed over the work surface, these supplies are instantly accessible merely by standing up and opening a cabinet door.

For books the obvious solution is bookshelves. Less obvious, but well worth considering by those who don't really enjoy dusting shelves, are book cabinets with glass doors that allow you to see the books, but keep dust at bay. These surprisingly affordable cases can usually be exactly matched to your desk and cabinets for a unified look in your office.

Nor should you overlook the legions of accessories and organizes available for the home office. The organizer designers seem to have thought of every conceivable carton and container for all of your office needs. Clear plastic organizers make storing small items like pens and pencils, staples, paper clips and printer cartridges a snap. Magazine boxes store your journals neatly on the shelf in annual volumes. For the less industrial look, wicker baskets in a variety of sizes can store just about anything and keep it well organized.

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