Don't Fear Home Office Deductions


Many tax preparers fear the home office deduction and tell their clients that claiming it raises a “red flag” on their return, setting off an IRS audit.

But not me — I love it! In 39 seasons as a professional tax preparer, I have never encountered an audit that questioned a client’s home office deduction.

The home office deduction was once a cause for concern, with IRS regulations and U.S. Tax Court decisions going back and forth on the definition of “principal place of business” as it applied to the requirements for a qualified home office. Thanks to the Taxpayer Relief Act of 1997, which expanded of the definition to include “used exclusively and regularly for administrative or management activities of your trade or business and [when] you have no other fixed location where you conduct substantial administrative or management activities of your trade or business,” things became much more simpler.

In the past, a home office deduction could have bit a taxpayer in an inconvenient place when selling his/her home. If a taxpayer claimed 10% of his/her personal residence as a home office, for example, then 10% of the capital gain on the sale could not be deferred or excluded under the applicable home sale rules.  But Congress came to the rescue, and today's homeowners no longer have to worry about paying tax on the business use percentage of the gain when selling the residence. They're only required to pay taxes on the depreciation claimed on the home office after May 6, 1997.

So, let's explain why I like the home office deduction. First, it reduces your Adjusted Gross Income. This means many deductions and credits will be phased out or lost entirely, and the amount of taxable Social Security or Railroad Retirement benefits may increase as one’s AGI goes up. As another incentive, reducing AGI can increase a multitude of other tax benefits.

Similarly, if you own your home claiming an office can move a portion of the real estate taxes and mortgage interest deductions, that would have otherwise been taken on Schedule A, from “below the line” to “above the line,” further reducing AGI. While a home office generally cannot be used to create a Schedule C loss, you can have a loss to the extent of the business use percentage of real estate taxes and qualified mortgage interest. This brings more value to the deductions for taxes and interest

Secondly, a home office deduction reduces not only your federal and state income tax but also your self-employment tax. The home office deduction could provide 40% to 50% in total tax savings!

And, perhaps the most important reason of all, having a qualified home office establishes your home as a place of business for the purpose of deducting business mileage. You have no “commute."  Every time you leave your home to drive to another business location (a client, the office supply store, your business bank) you have deductible round-trip business mileage.

So what if experts fear claiming a home office deduction can increase your chances of an audit. Tax decisions should be made based on tax law--not on potential audit risk.

While a tax audit is indeed an inconvenience, and has great potential for agita and aggravation, it's not something “evil” to be avoided at all costs. If your deduction is legitimate, and properly documented, you honestly have nothing to worry about.

I have issues with tax “professionals” who advise a client not to claim a legitimate home office deduction, or any other legitimate deduction, for no other reason than to avoid an audit. This is truly terrible tax advice.

I agree with former IRS Commissioner Donald Alexander, who said, "As a citizen, you have an obligation to the country's tax system, but you also have an obligation to yourself to know your rights under the law and possible tax deductions — and to claim every one of them."

To learn more about the rules and regulations for claiming a deduction for a home office, talk with a tax professional.

And if you qualify, go ahead and take full advantage of the home office deduction.  Your bank account will thank you!

—New Jersey tax pro Robert D. Flach has been preparing 1040s for individuals since 1972.

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