Consider home office expenses !

More and more business people of the nineties are avoiding unnecessary overhead costs by moving into the most comfortable office of all—home.  It is an easy way to convert otherwise non-deductible home expenses into deduct­ible expenses.  Watch out though.  Like most tax incentives, you must pass certain tests to ensure that you qualify for the deduction.  Keep in mind that major renovations to the house for business purposes are excluded from this article.

Does your home office qualify?

Home office qualification is determined annually. Each year you must meet one of two conditions to qualify, which are as follows:

1. Is your home office your principal place of business?

2. Is your home office used exclusively to earn business income and used to meet customers on a regular basis for business purposes?

Is your home office your principal place of business?

The first qualification is easy to determine.  If your home is your main place of business, your expenses are eligible.  However, if you have two or more places of business your qualification is based on whether your home office is the main place at which you conduct your business affairs.  Examples of activities that support your home office as your principal place of business include receiving work orders, bookkeeping, purchasing, payroll and performing services.  Keep in mind that if you can prove that your home is your principal place of business, you can use your home office space for personal use without losing the business expense deduction.  This is where the first and second qualifications differ.

Is your home office used exclusively for business purposes?

The second qualification is commonly used for individuals who have two or more places of business.  The second qualification is met if two requirements are fulfilled. 

First, you must meet your customers on a continuous and regular basis at the home office and, second, the home office must be used exclusively to earn business income.  The key word is “exclusively” unlike the first criteria that allows personal use of the office as well.  However, just having an office at home, which is used exclusively for business purposes, does not qualify as a home office. 

Second, you must also meet your clients on a regular and continuous basis at your home office.  Of course this use will vary depending on the nature of your business and is determined on an individual basis.  If both requirements are fulfilled, you are eligible to deduct a reasonable portion of your home expenses.

What expenses are deductible?

Now that we have determined if you qualify for home office expenses or not, we must now determine what constitutes a reasonable deduction.  This reasonability can be determined in a number of ways.  A common method is taking the percentage of the total space of the office compared to the total space of your home and applying this percentage to the home expenses such as rent, property taxes, insurance, mortgage interest, repairs and maintenance, and heat and electricity.  Since claiming capital cost allowance on your home can prove to be detrimental by leading to recapture when the house is sold and disqualifying a portion of your home for the principal residence exemption, it is rarely claimed.

Home office expenses are only deductible up to the income earned within the business.  In other words, you cannot create or increase a loss by claiming home office expenses.  Fortunately, the unclaimed home office expenses are not lost and can be carried forward indefinitely to offset future business income as long as the home office still qualifies for the deduction.

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