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