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Audit proof a home office
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October 16, 1997: 10:08 a.m. ET
IRS denies targeting home-office deductions, but experts advise caution
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NEW YORK (CNNfn) -- More and more Americans are becoming self-employed and working out of their homes, but fewer and fewer are claiming tax deductions for business use of their houses.
Why?
"It's too much trouble and increases the possibility of a tax audit," says Susan Jacksack, a tax lawyer and small-business analyst.
Internal Revenue Service rules allow people who work out of their homes to deduct, under certain circumstances, portions of costs like utilities and rent or mortgage-interest payments.
However, IRS figures show that the number of filers claiming home-office deductions has declined from a high of 1.61 million in 1991 to about 1.6 million in 1995, the latest year for which figures are available.
Not only have the numbers fallen, but even 1991's record figures are insignificant when compared to the 120 million tax returns Americans file each year.
IRS spokesman Don Roberts said the agency doesn't see a single reason for such a low usage of the home-office deduction.
He said it's possible that many filers either don't fully know about home-office deductions, or just don't bother to take advantage of available tax breaks.
But tax attorney Jacksack said IRS procedures for claiming home-office deductions are too cumbersome and vague, and that many of the filers are reluctant to claim the deduction for fear they'll get audited.
"The IRS will never come and tell you who is likely to be audited, but generally, filers (who take home-office deductions) tend to be more frequently audited," Jacksack said.
Statistics seem to bolster Jacksack's contentions.
The IRS does not release any figures on the frequency of audits for taxpayers filing Form 8829, "Expenses for Business Uses of Your Home."
However, a study by CCH Inc., a Chicago-based tax- and business-law reporting firm, found the IRS audits a higher percentage of filers who fill out Schedule C, "Profit or Loss from Business (Sole Proprietorship)."
In 1995, the last year with data available, the tax agency audited 5.85 percent of individual filers who filled out a Schedule C and made $25,000 or less, compared with only 1.96 percent of similar taxpayers who didn't make out a Schedule C.
And in the $100,000 and over category, 3.47 percent of Schedule C filers got a date with the tax man, compared with only 2.79 percent of those who didn't fill out a Schedule C.
Still, the IRS's Roberts maintains that the concern of a home-office deduction triggering an audit "is a very incorrect perception."
Roberts admitted that until 1991, the home-office deduction was "one of the top 10" categories in terms of audit frequency. "However, since 1991, it is not even in the top 30," he said.
The IRS spokesman also said Form 8829, introduced in 1991, has considerably simplified the procedure for claiming home-office deductions.
"The form provides easy and clear guidelines," Roberts said. "It is a one-page form that tells you step-by-step how to do it."
Filers can find a home-office deduction lucrative. The 1.6 million Americans who took the deduction in 1995 claimed a total of about $3 billion, or about $2,000 per filer.
Keeping the IRS at bay
How do you claim the deduction and still stay on the IRS's good side?
The important thing to remember is that you can only take a limited deduction for the business use of your home -- and only if you use a part of your home "exclusively and regularly" for business.
If you maintain a home office but are not self-employed, the business use of your home must be for your employer's convenience. However, you can't take a home-office deduction if you rent all or part of your home to your employer to perform services there as an employee.
Additionally, the IRS says "exclusive" use of part of the home means just that -- use strictly for business.
If you use part of your home as your business office but also use the same area for personal purposes, you don't meet the IRS's "exclusive-use" test.
For example, a lawyer cannot claim a deduction for a den if he uses the room not just to write legal briefs, but also to watch TV.
The only exception to the "exclusive-use" rule involves using part of your home for a day-care facility, or as a place to store inventory or product samples.
To meet the IRS's "regular-use" test, you must use a part of your home on a continuing basis.
The IRS says occasional or incidental business use of that part of your home will not meet the test, even if you never use the area in question for any personal purpose.
IRS rules also say you must determine whether your home office is the principal place of your business, and must pass this test for every trade or business activity you conduct at home.
For example, a school teacher who runs a mail-order business exclusively from her home can take a home-office deduction if she meets all requirements -- but can only deduct expenses related to the mail-order business.
However, if she makes any use of the home office for work related to her teaching, she cannot take a home-office deduction for either activity.
Calculating deductions
To calculate deductions for the business use of your home, first find the "business percentage" of your dwelling.
Divide the area of your home used for business purposes (in square-foot terms) by the total area of the dwelling.
For example, if you have a condominium with 1,000 square feet of space in total and you use a 10 foot by 10 foot room as a home office, the "business percentage" of the dwelling is 10 percent ((10 square feet x 10 square feet) divided by 1,000 square feet).
You can then deduct the "business percentage" of your mortgage interest or rent, local real-estate taxes, utilities, and services like security systems or trash removal.
Thus, if you pay $1,000 a month in rent on a condominium with a 10 percent "business percentage," you can deduct $1,200 a year ($1,000 a month x 12 months) divided by 10) as a business expense.
Keep records
The IRS says record keeping is important. The agency says you do not have to use any particular bookkeeping method, but whatever records you have must provide the information needed to figure your deductions.
You must keep the records for as long as required under law -- usually three years from when you file the tax return.
If you need more information, send for IRS Publication 587, "Business Use of Your Home."
One warning from Jacksack - don't try to outsmart the IRS or make outrageous claims.
"They can and will find out," she said. "I know of one author who tried to write off his entire home saying he needed to use every room for inspiration to write. He didn't win."
-- Harihar Krishnan
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