Avoiding tax pitfalls will keep your home office a benefit 

I am going to start working at home this summer and plan to set up a home office. What deductions are available to me and how should I keep track of expenses? L.H., Indianapolis

For people who work at home, the IRS permits deductions for the cost of the business use of the home, as long as certain requirements are met. The space allocated to a home business must be used exclusively for business and on a regular basis. If you work at the kitchen table, then slide your work aside when it’s time to sit down for dinner, that space does not qualify as space used exclusively for your business, even if you work there every day. If you use a vacant room of the house for one business project, and then don’t use it for the rest of the year, the space is not used on a regular basis.

Recent changes to the tax laws permit a person to use a portion of the home as a home office or home business if there is no other space available for performing administrative duties, even if the person performs much of the job away from the home office. The example used by tax authorities to illustrate this situation is of an anesthesiologist who performs his medical work at several different hospitals, but uses his home office for billing, research, and scheduling because he has no other place where he can perform these duties.

If you qualify for a home office deduction, you are allowed to deduct a proportionate share of expenses such as mortgage interest, real estate taxes, homeowner’s insurance, utilities, and maintenance (such as trash removal, septic service). You can also take a deduction for a proportionate share of repairs, such as roof repair, that affect the entire home.

When you fill out your tax forms, you will fill out Form 8829, Expenses for Business Use of Your Home. The expenses on this form will flow through to the form on which you report your business income (Schedule C, for example, if you are self-employed) or to your employee expense form (Form 2106) if you are an employee.

Form 8829 asks for the square footage of the space used for your home business and the square footage of your entire home. If you can’t figure out the square footage, you can enter the number of rooms used for your home business and the total number of rooms in your house or apartment. The percentage that results from dividing your business space by the space of the entire home is the percentage that will be applied to your home expenses for purposes of calculating your deduction.

Watch out for home office pitfalls

Here are a couple of things you should be aware of when taking a deduction for a home office. First, your deduction for the home office expenses that are not deductible on another schedule of your tax return (such as mortgage interest and property tax, which could be deducted on Schedule A) must not contribute to a loss in your business. If your business is operating at a loss, your home office deductions will not be allowed because they will only increase the loss. The theory is that you would have these home expenses whether or not your business operated from the home, so you can’t use the expenses to increase a loss in a business that is not making any money. You will, however, be able to carry unused deductions over to the next year.

Keep in mind that if your business is operating at a loss, and there are home expenses that relate directly to your business space, such as plumbing expense for your dark room or telephone wiring for the computer in your office, those expenses are directly attributable to your business and are allowed as a deduction even if they create a loss in the business.

Second, if you claim a deduction for the business use of a home that you own, you must take a deduction for depreciation expense on the portion of the home being used for business. This generates a nice deduction in the years in which you operate the business, but taking this deduction may result in a taxable gain when you sell the house.

Keep records for three years

Regarding record-keeping requirements for your home office, I suggest that you keep cancelled checks and the bills you receive for your utilities, keep the year-end mortgage statement that you receive from your mortgage lender, and keep any other receipts relating to repairs or other home expenditures. These records should be kept for three years after you file your tax return.