b. Be familiar with the types of expenses that can be deducted. c. Understand special rules for daycare providers.

Transcription

1 HOME OFFICE

2 Course Description Regardless of whether a taxpayer is self-employed or an employee, if he uses a portion of his home exclusively (and regularly) for business purposes, he may be eligible for a home-office deduction. With advances in technology and wider acceptance of telecommuting, it is especially important now more than ever to understand the rules of deducting the business use of a home. 1. Training Objectives When you have completed this training, you will: a. Know the requirements that qualify for expense deductions for the business use of your home. b. Be familiar with the types of expenses that can be deducted. c. Understand special rules for daycare providers. d. Be familiar with how to figure the deduction and how to calculate expenses. e. Know what records should be kept when deducting for the business use of your home. 2

3 2. What constitutes a home-office deduction? Taxpayers may be allowed to deduct some expenses that are related to the business use of their home, but in order to do so, they must meet certain requirements, which are detailed below. a. Exclusive Use - In order for a taxpayer to pass the "exclusiveuse" test, the taxpayer must have a specific area of his home that is used solely for trade or business. In this case, a specific area can refer to a room or other identifiable space. It is not necessary that the space be marked off with a permanent wall or partition. Taxpayers do not meet the exclusive use criteria if the space designated as workspace is used for both work and personal use. i. Storage Exception - Deductions can apply to portions of the home that are used for storage or inventory of product without meeting the exclusive use test. This is provided if the following are ALL true: 1. The products in question are sold (either wholesale or retail) as the taxpayer s trade or business. 2. The storage is for inventory or samples that are used in the taxpayer s trade or business 3. The storage space is used on a regular basis. 4. The storage space is a separately identifiable space. 3

4 Example Brent is a writer and prefers to work in the dining room of his family home after everyone is fast asleep. Because the family also uses the dining room for meals, Brent cannot claim a deduction for business use of the dining room. Example Janelle sells yarn out of her family home, storing the goods in the basement. Even though her basement is also a recreational room utilized by the rest of the family, the expenses for the yarn storage space are deductible, as the exclusive use rule does not apply for spaces used for storage. ii. Daycare Use- Though this will be discussed later in the course at length, the other exception to the exclusive use rule applies when the home business use is that of a daycare. In this instance, please reference rules that are specified for Daycare Facilities (See "Daycare Facilities" later in this course.) b. Regular Use - Taxpayers must regularly use the space in question. Occasional or incidental use does not qualify as regular use. When determining whether this rule has been met, it is important to weigh all of the circumstances of the business. c. Trade or Business Use- Taxpayers must use part of their home in connection with a trade or business in order for it to be tax deductible. 4

5 Example Sarah has a home office that is dedicated to writing her blog and organizing her photographs; however, Sarah is a podiatrist and makes no money from her writing or photography. Therefore, even though she has a dedicated office, she cannot deduct that space as a home business. d. Principal Place of Business - Though taxpayers can have more than one business location for a single trade or business, in order to deduct associated expenses for use of the home as a business, the home office must be the principal location for that business. This qualification is determined by the following: i. Relative importance of activities at each business location ii. Time spent at each business location iii. In the case of a home office, it can be considered a principal place of business if It is used solely and regularly for administrative or management activities of the taxpayer s business, AND There is no other fixed location where the taxpayer could substantively conduct administrative or managerial activities. a. Administrative and Managerial Activities include Billing Bookkeeping 5

6 Ordering supplies Setting appointments Writing when related to the trade or business b. Administrative and Managerial Activity Exceptions There are some activities that will NOT disqualify a home office from being classified as a principal place of business 1) Administrative or management activities are conducted at locations other than taxpayer s home office by OTHER people. 2) Administrative or management activities are conducted at locations that are not fixed (such as in hotel rooms or on a train.) 3) Administrative or management activities are occasionally and minimally conducted outside of the home office. 4) NON administrative or NON management activities are conducted at a fixed location outside of the home office 5) Though the taxpayer has a space outside the home that would be suitable for conducting management or administrative tasks, the taxpayer opts to perform the work at the home office. Example Angela is an interior designer who has a home-based business. In her home, she has an office where she keeps all of her samples, does her bookkeeping, takes calls, and makes appointments. However, most of her work is done at her clients homes and in retail stores. 6

7 Angela's home office qualifies as her principal place of business because the business that she conducts outside of her office is not at a fixed location. Angela performs all of her managerial and administrative work in her home office and can therefore deduct expenses for the business use of her home. e. Multiple Businesses Taxpayers may have a qualified home office that is the principal place of business for two or more distinct business activities. It is important to note that though the space can be used for two or more business activities, it cannot be used for personal activities. Each of these principal uses must be determined separately for each of the businesses and must be used regularly and exclusively as one of the following for one or more businesses or trades: i. As the principal place of business ii. As a place to conduct business with clients, patients or customers iii. As a space that is a separate structure (such as a garage, shed, or studio) f. Meeting Clients, Patients or Customers Taxpayers may deduct expenses related to the portion of the home used exclusively and regularly for business, even when some business is carried out at a separate location. If the space being deducted is normally used for meeting clients, patients and customers, expenses may still be deducted even when some business is carried out at a separate location. However, using the home-office space for occasional meetings and telephone calls will not meet this requirement. In general, home professionals such as counselors and attorneys who maintain a home office will meet this requirement. Specifically, BOTH of the following must be true: 7

8 i. The taxpayer physically meets with patients, client or customers in the office. ii. An integral part of taxpayer s business is meeting clients, patients or customers in taxpayer s home. g. Separate Structures Taxpayers may deduct expenses for a separate structure such as a shed, studio or garage if it is used exclusively and regularly for business. If the structure is free-standing, it does not have to be the principal place of business nor must it be a place where the taxpayer meets clients, customers, or patients. 3. Home-Office Deduction: The numbers Once it has been determined that the taxpayer qualifies for the home-office deduction (according to the terms of the above section), it is time to determine how much can be deducted. This calculation is done by first figuring the percentage of the home that is used for business as well as the limit of the deduction. If the taxpayer rents a portion of his home to his employer and that portion is used to perform work as an employee, the amount that can be deducted is limited. Under these circumstances, the taxpayer cannot deduct trade or business expenses, business casualty losses, or depreciation of the home related to this use. However, the taxpayer CAN deduct the following (which are subject to limitations): mortgage interest mortgage-insurance premiums (qualified) 8

9 real-estate taxes personal casualty losses for the rented portion of the home. a. Calculating Business Percentage In order to find the business percentage of the taxpayer s home, tax preparers should compare the total size of the home to the portion of the home that is used for business. This can be done by any reasonable method. There are two common methods for determining this percentage i. Divide the total area of the portion of the home used for business by the total area of the home. (Total area is calculated by multiplying the length of the space by its width.) ii. In a house that is comprised of rooms that are all approximately the same size, the preparer can divide the number of rooms that are used for business by the total number of rooms. Example Stuart has a home that is 2,000 square feet. He has a qualified office that is 500 square feet. By calculating the business percentage using total areas ( = 0.25), it is determined that the business percentage of Stuart s home is 25%. Example Sharon has a home that consists of 8 rooms that are all about the same size. Two of those rooms are qualified offices. In calculating by room (2 8 = 0.25), it is determined that the business percentage of Sharon s home is 25%. 9

10 b. Part-Year Use In figuring deductions, taxpayers can only deduct expenses for use of a portion of their home for the time when it was actually used. If taxpayers meet the criteria for a home office but only for the last six months of the year, they can only deduct expenses for that half of the year. c. Multiple Places of Business If taxpayers conduct business at more than one location with one of the locations being that of the home office, the proportion attributable to the home office must be determined and expenses adjusted accordingly. In order to do this, factor time and money spent at each location as well as any other relevant factors. Then adjust expenses derived from the home office accordingly. Example In July, Samantha built a small home office in her yard. Even though the separate structure qualifies for the deduction, Samantha must only deduct for the time that the structure was used as an office- six months. Any calculations to figure deductions must be accordingly multiplied by 50%. d. Deduction Limits - In some cases, the amount taxpayer is permitted to deduct is limited. If their gross income from the use of their home is GREATER than the total business expenses, they can deduct all business expenses related to the use of their home. However, if taxpayers gross income from the use of their home is LESS than their total business expenses, their deduction for certain expenses in terms of the 10

11 business use of the home, is limited to the gross income from the business use of the home MINUS the sum of i. Business expenses that could be deducted regardless of home business (such as mortgage interest, real estate taxes, and casualty and theft loses.) ii. Business expenses that relate to work in the home but not the home itself (such as phone, office supplies, and equipment depreciation.) In the case that deductions are greater than the year s limit, the excess can be carried over to the next year. To figure the deduction limit and the carryover, use the IRS Worksheet to Figure the Deduction for the Business Use of Your Home, for taxpayers that are filing Schedule F (Form 1040) and Form 8829 for taxpayers filing Schedule C (Form 1040.) 4. Deducting Expenses Taxpayers who qualify to deduct expenses for the business use of their home must make a distinction between expenses incurred as a result of business use and those that are not a direct result of business use. As such, there are different types of expenses which are calculated by first determining If the expense is direct, indirect, or unrelated, AND 11

12 The percentage of the home dedicated to business use a. Types of Expenses: Type of Expense Direct Indirect Definition Examples Deductibility Expenses that apply ONLY to the business portion of your home. Expenses incurred while maintaining the home as a whole Purchasing a new desk Utilities, Mortgage Insurance, General Repairs Can be deducted in full. (An exception exists for daycare facilities, which may be based on a percentage.) Deductible based on percentage of the home used for business In general, expenses that are related to tax-exempt allowances are not deductible. However, parsonage and military allowances enable taxpayers to claim expenses for mortgage interest and real estate taxes as deductions. In the case that housing is provided for free and is tax exempt, the rental value of any portion of that housing is NOT deductible. b. Examples of Expenses Aside from direct and indirect expenses, there are two other types of expenses: those that would be deductible regardless of home-business use and 12

13 those that taxpayers must have a home business to deduct. Both expenses are calculated using the business percentage that was calculated earlier. Deductible regardless of home business status real estate taxes mortgage premiums mortgage interest casualty losses Must have home business to deduct home depreciation insurance rent (paid for property used for business) repairs security utilities i. Calculating Expenses - In general, home-office expenses are calculated by multiplying the amount the taxpayer paid in the previous year by the percentage of the home that was used for business (as calculated earlier); however, there are some exceptions to that rule. ii. Real Estate Taxes are calculated in a straightforward manner with the amount paid in tax multiplied by the percentage of the home used for business. iii. Mortgage Interest is also calculated by multiplying the total mortgage interest paid out by the business percentage which can include payment on second mortgages. Taxpayers that have a total mortgage debt of greater than $1,000,000 or total home-equity debt greater than $100,000 should reference the IRS to ensure their deduction is not limited. iv. Mortgage Insurance deductions are calculated by multiplying the premium payments by the business percentage. Mortgage insurance deductions may be limited for those taxpayers who have an adjusted gross income of greater than $100,

14 14 v. Insurance deductions can be made for the portion of the insurance that applies to the home business. Care should be taken to only deduct premiums that apply to the tax year in question. vi. Rent paid on a home that is partially used for business purposes can be deducted for the percentage that is used solely for business (with an exception for daycare facilities.) vii. Repairs that are solely for the benefit of your business space (repair to a window in a home office, for example) can be deducted in their entirety. Those that benefit the whole house can be deducted according to the established business percentage. viii. Security If the taxpayer installs a security system for the home, the business portion of the expenses can be deducted as can the depreciation value of the cost of the security system that relates to the business use of the home. ix. Utilities The types of utilities that can be deducted are reasonably related to the type of business conducted in the home. In general, the amount of utilities (such as gas, trash, and cleaning) is the same as the business percentage. (An exception to this is the calculation for telephone bills which are deducted separately. Second lines and charges for long-distance calls conducted in the course of business are considered business expenses.)

15 Example Over the summer, Sarah's air conditioner broke down. Sarah repaired it. She deducts 10% (the business-use percentage of her house) of the repairs costs because the repair also benefited her qualified home office. x. Casualty Losses are calculated in different ways depending on how the loss was incurred. Direct expense- a loss that only impacted the business. The entire loss is used to calculate the deduction. Indirect expense- a loss that impacted both the business and the home itself. Only the percentage of the loss that impacted the business is used to calculate the deduction Unrelated expense- a loss that does not impact the business cannot be used to calculate a deduction. Example A hail storm damages the siding on Cindy's home. 20% of the home is used for business. She has to have the entirety of the home's siding replaced. In terms of deductions, Cindy can only deduct 20% of the total cost of 15

16 replacing the siding as a business expense as it is proportional to the area of the home used for business. 6. Equipment and Furniture Deductions for furniture and equipment used in a home business or for work as an employee are available regardless of whether taxpayers qualify to deduct expenses for the business use of their home. There are, however, different rules that apply to three different types of properties: listed property, property bought for business use, and personal property converted to business use. a. Listed Property includes computers and related equipment as well as property that is generally used for entertainment (such as stereos, televisions and photographic equipment.) i. Computer Exception- Computers (as well as related equipment such as printers) that are used only in a qualifying home office are not considered listed property and are instead considered "Property Purchased for Business Use" and should be deducted accordingly. ii. More than 50% Use - Listed property that was used for business within the tax year must be used more than 50% of the time for business. If this is not the case, the property cannot be claimed as a section 179 deduction or a depreciation deduction. The 50% is calculated based on its total use. iii. Employees- Use of listed property by employees is considered business property only if the following is true: The use is for the convenience of the taxpayer's employer 16

17 The use is required as a condition of employment iv. Ensuing years- If use of an item falls below 50 percent subsequent to being identified as a business property, the taxpayer might be required to Figure depreciation starting the year that the use fell off Calculate excess depreciation and add it to their gross income and adjusted basis of property. Example Arthur bought a printer for use in his home office but allowed his daughter to print posters for an upcoming talent show at her school. Though the poster printing counts as personal use, it is well below 50% of the printer's total use. Arthur therefore qualifies to claim the printer, which is not considered listed property. v. Recordkeeping If listed property is used in a business, the taxpayer must file Form 4562 to claim a depreciation or section 179 deduction. b. Property Purchased for Business Use Taxpayers who purchased property for their business have three options: i. Section 179 deductions for full cost Taxpayers may claim the section 179 cost of personal property purchased for use in their trade or business by choosing how much to deduct and depreciate, provided it falls within stated limits. This is done by completing Part I of Form

18 ii. Depreciate the full cost of the property Taxpayers can elect to depreciate their business property by completing Parts II and III of Form Typically, depreciation is for either five- or seven- year properties under MACRS. Five year property includes machines such as printers, copiers, computers and the like. Seven year property includes fixtures and furniture such as safes, file cabinets, and desks. To use the MACRS table, first determine the cost of the depreciable property. Then determine whether it is a five- or seven- year property. (With this table, the "half-year convention" can be used. Typically, though, special circumstances can sometimes apply.) MACRS Percentage Table for 5- and 7- Year Properties (Using the Half-Year Convention) Recovery Year 5- Year Property 7- Year Property % 14.29% % 24.49% % 17.49% % 12.49% % 8.93% 18

19 6 5.76% 8.92% % % Example Two years ago, Tony purchased a file cabinet for his office for $525. Tony elects to take the deprecation deduction. Using the chart above, given that office furniture is a 7-year property under MACRS, Tony multiplies $525 by 24.49%, which is $ This number is his MARCS deprecation deduction. iii. A mix of 179 and depreciation of the property cost Taxpayers can also elect to combine the two methods above to deduct property making sure that the combination does not exceed the value of the property, taxpayers may take a portion of the cost as a section 179 deduction and depreciating the balance. c. Personal Property Used for Business Taxpayers cannot take a section 179 deduction for property used in business that was previously used for personal purposes; however, it can be depreciated. If the property has changed uses in the last year, taxpayers should use the MACRS table to determine the depreciation. 19

20 Value of the property is determined by the LESSER of the following on the date it changed use the adjusted basis the fair market value Property that was used for personal purposes between 1980 and 1987 and changed to business use in the last year may be subject to special evaluation. 7. Home Depreciation Homeowners who qualify to deduct expenses of their home for business use are also qualified to claim a deduction for depreciation. In this context, depreciation deductions are an acknowledgment of the wear and tear on the part of the house that is used for business. There is no deduction for depreciation of land values, however. a. Information needed to calculate a deduction: Month and year the taxpayer began using their house for business Fair market value and adjusted basis (cost of permanent improvements made by the homeowner 20

21 minus any casualty losses) of the home when the taxpayer began using their home for business Cost of improvements to the home made before and after the taxpayer began using it for business Business percentage of the home as defined earlier. Taxpayers must be careful to distinguish between repairs (which also may be deductible though not as depreciation) and improvements. Permanent improvements are those that add to the value, life, or use of a property. Example Genevieve purchased an older home. She fixed the former housekeeper s living quarters so that it might be a suitable place for her work as a massage therapist. She enclosed the porch, and added a path to the external door, which brought the room up to code. Normally, this work would be deductible as repairs, but because this particular work gave the house a new use, it is considered to be a "permanent improvement" and cannot be deducted as a repair expense. b. Calculating Home Depreciation i. If the taxpayer has previously used their home for business and deducted for depreciation, they are to use the same method of calculation used previously. ii. If this is the first year the taxpayer is calculating their home depreciation deduction for business-use, they are to use the modified accelerated cost recovery system (MACRS) and depreciate the business use portion of their home as nonresidential real property. (see below) 21

22 Multiply the adjusted basis value (cost + cost of permanent improvements - casualty losses) by the business use percentage previously calculated. This is the depreciable basis. Using the MACRS table below, find the percentage based on the first month the taxpayer used their home as a business. Multiply the depreciable basis (calculated in the last step) by the MACRS number. The total is the depreciation deduction. MACRS Percentage Table for 39-Year Nonresidential Real Property % % % % % % % % % % % % Example Stuart began using his home office in March of this year. The adjusted basis value of his home, including recent improvements is $170,000. His business 22

23 use percentage is 15 % (Stuart uses 15 percent of his house exclusively for business.) This means that his depreciable basis is $25,500. Because March is the third month of the year, he then multiplies that number by 2.033%, (or ), arriving at a depreciation deduction of $ iii. Permanent improvements made in years after the home was first used as a home business are calculated separately using the exact same method (multiplying the cost of improvement by the business use percentage and multiplying that number by the MACRS number for the month the improvement was made.) 8. Daycare Facilities Taxpayers who use space in their home for providing daycare on a regular basis may be exempt from the exclusive use rule. This means they may be able to deduct the business expenses for the part of the home where the daycare is provided even if they use that same space for nonbusiness (personal) reasons. In figuring the deduction, the same reasonable methods of calculation should be used. The difference is that the taxpayer must also calculate the proportion of time that the space was used for business and deduct accordingly. This is true only for daycare facilities that are not used exclusively for business. 23

24 Example During the day, Denise runs an adult daycare in her home, hosting local seniors in her furnished basement. While her business is not in operation, the basement is used by Denise and her family as a rec room and place to watch television. Even though this dual use would normally disqualify Denise's right to deduct the space as business use, because her home business is considered a daycare facility, she is able to deduct the space for the hours that it is in operation. (See Below.) It is not necessary to keep records showing the time that the space was used for business. a. Qualifying In order to qualify as a daycare facility, both of the following must be true: i. The facility must provide care to children, seniors (aged 65 or older) or people who are physically or mentally unable to provide care for them. ii. The taxpayer must have applied for, be exempt from, or be in possession of a valid license or other certification (as required by state law) that states they may operate as a daycare center. Taxpayers who have been rejected from this certification or have had it revoked do not meet this test. b. Calculating To calculate the deduction for an in-home daycare facility that exclusively uses the home space; the 24

25 same methods are employed as are used for any home business. To calculate the deduction for an in-home daycare facility that is NOT an exclusive use, it is necessary to figure both the percentage of dedicated space that the business uses but also the proportion of time that it is used in order to develop the business-use percentage. To do this, divide the time that the space is used as a daycare facility by the total time it can be used. This number, multiplied by the percentage of the space of the facility used constitutes the business-use percentage for a daycare facility. Example Marcie has a home daycare business. She watches six children five days a week, on the first floor of her home. She is open ten hours a day during the week. The area of her daycare business is 1,000 square feet in a house that is 2,000 square feet total / 2000 = 50%, which is the business percentage of her business. To calculate the percentage of time, Marcie divides the hours that her business is open in a year (2600) by the total hours in a year (8,760). 2600/ 8760 = 29.68% To calculate the percentage, she can deduct for indirect expenses (expenses that apply to the entire house) Marci multiplies the two numbers together. 50% x 29.68% = 14.84% Marci can therefore deduct 14.84% of all indirect expenses for her home daycare. 25

26 c. Meals If the daycare facility provides food for those that are being cared for, this expense is not included as a cost of doing business. It is a separate deduction. Additionally, food consumed by the taxpayer or their family can never be claimed. If the cost of meals is deducted, a separate record should be kept. Government reimbursements are taxable only if they are more than the expenses for food (See Part I of Schedule C Form 1040) To deduct the cost of meals provided as part of a daycare business, taxpayers should use standard meal and snack rates. Standard Meal and Snack Rates i. Standard meal and snack rates As a qualified daycare provider, taxpayers have the option of using standard meal and snack rates following guidelines and allowing for a maximum of one breakfast, one lunch, one dinner and three snacks per child per day. Taxpayers have the option of using the actual costs of food to calculate the deductible cost of food or the standard rates on the table below. If the taxpayer elects to use the standard rates, they must be used across the board, and records must be kept. While standard rates do include beverages, they do not include other food-prep costs (such as non-food supplies like silverware and cups.) Those costs can be deducted separately Location of Breakfast Lunch Dinner Snack 26

27 Daycare All states other than Alaska and Hawaii $1.19 $2.22 $2.22 $0.66 Alaska $1.89 $3.60 $3.60 $1.07 Hawaii $1.38 $2.60 $2.60 $ Recordkeeping In keeping records, it is not necessary that taxpayers adhere to a particular method; however, they must keep records that show evidence of the deductions made (such as canceled checks, receipts, and other things that show expenses were paid.) Specifically, records must show a. The part of the home that was used for business b. Proof that the portion of the home used exclusively for business was the taxpayer's principal place of business or where the taxpayer met with clients, patients, or customers. (unless the business use falls under one of the exceptions to business use) c. Depreciation and expenses for the business use of the home. i. Records to prove the home's depreciable basis must be retained including: When and how the home was acquired The original purchase price of the home Improvements made to the home Deprecation of the home due to home office use 27

28 Copies of Form 8829 or IRS business deduction worksheets. ii. Records must be kept for: Three years from the date filed (or return due date) Two years after tax was paid 11. Tax Forms for the home-office deduction Deductions of expenses for the business use of a home are done on Form 1040, but where the deductions are made on the form is dependent on whether the taxpayer is an employee or self-employed. a. Self-employed Taxpayers i. Filing Schedule C on Form 1040 should complete and attach Form 8829 to their return ii. Filing Schedule F on Form 1040 should report their deduction for the business use of the home on line 32 of Schedule F, entering "Business Use of the Home" on the dotted line beside the entry. To determine limits of deductibles and figure individual deductions (mortgage insurance payments, real estate taxes, etc.), taxpayers can use the IRS "Worksheet to Figure the Deduction for the Business Use of Your Home," which can be found online. b. Employees must itemize deductions on Schedule A of Form 1040 in order to claim a deduction for the business use of their home and employee business expenses. An exception to this rule is for statutory employees who should file Schedule C to claim their expenses. 28

29 i. Employees must in general file Form 2106, if: They claim any job-related vehicle, transportation, travel, or entertainment expense. They were paid by their employer for job expenses reported on line 21 of Schedule A ii. Employees may use 2106 EZ instead if: They were not reimbursed by their employer for expenses or if those reimbursements were included in box 1 of the employee's W-2 Form. The employee uses the standard mileage rate in claiming car expenses. If the employee adequately reports and is compensated for expenses, neither should appear on the W-2, and neither the income nor the expenses should be reported. In the case that an employee has qualified mortgage interest, mortgage insurance premiums, real estate taxes, or casualty losses to report as expenses, they should consult the IRS publications specific to these topics to determine how they should be reported. iii. If employees report their expenses using 2106 or 2106-EZ, taxpayers should report Business expenses not directly related to the home The qualified business use of otherwise nondeductible expenses such as utilities or repairs. 29