Harvey & Parmelee LLP
Certified Public Accountants

Tax Tips

Business Use of the Home - Part II - August 2000
Richard Scrivanich - Partner

Last month, we discussed how to qualify for the business use of your home deduction. In order to qualify for the deduction, you must meet a two-part test. The first part has three criteria, that is, the use must be exclusive, regular, and for your trade or business. The second part of the test requires you to meet only one of the following criteria: The business part of your home must be: 1) your principal place of business or 2) a place where you meet or deal with patients, clients, or customers in the normal course of your trade or business, or 3) a separate structure (not attached to your home) you use in connection with your trade or business. Once you meet these tests, you are eligible to take the deduction.

Q: I'm eligible for the deduction, but I'd like to know how it is computed?
A: To figure your deduction, you need to know that your deduction is limited by the following:

1. The percentage of your home used for business (business percentage), and
2. The deduction limit.

Q: What is the business percentage?
A: The business percentage is calculated by comparing the size of the part of your home that you use for business with the size of your whole house. The resulting percentage is used to figure the business part of the expenses for operating your entire home. You can use any reasonable method to determine the business percentage. The following are two common methods you can use to figure the percentage.

1. Divide the area (length multiplied by width) used for business by the total area of your home.
2. Divide the number of rooms used for business by the total number of rooms in your home. You can use this method if the rooms in your home are all about the same size.

Q: I started using my home for my business on July 1 of this year. Can I still take the deduction?
A: Yes, but only for the part of the year you did use your home for business purposes. Since you started using the home for business in July, consider your expenses only from July 1 until the end of the year in figuring your deduction.

Q: What is the deduction limit?
A: If your gross income from the business use of your home equals or exceeds your total business expenses (including depreciation), you can deduct all your business expenses. If your gross income from that use is less than your total business expenses, your deduction for certain expenses for the business use of your home is limited. Your deduction of otherwise nondeductible expenses, such as insurance, utilities, and depreciation allocable to business, is limited to your gross income from the business use of your home, minus the sum of the following:

1. The business part of expenses you can deduct even if you did not use your home for business (such as mortgage interest, real estate taxes, and casualty and theft losses).
2. The business expenses that relate to the business activity in the home (for example, salaries or supplies), but not to the use of the home itself.

Q: What happens to any expenses that aren't allowed? Can I use them another year?
A: If your deductions are greater than the current year's limit, you can carry over the excess to your next tax year. They are subject to the gross income limit from the business use of your home for the next tax year. The amount carried over will be allowable only up to your gross income in the next tax year from the business in which the deduction arose, whether or not you live in the home during that year.

Q: What types of expenses are deductible?
A: Whether you can deduct an expense depends on two things:

1. Whether the expense is direct, indirect, or unrelated to your business, and
2. The percentage of your home that is used for business.

A direct expense is one that is incurred only for the business part of your home, such as painting the area used for the business. This would be deductible in full. An indirect expense is one that you incur for running your home, such as insurance, utilities, and general repairs. An indirect expense is deductible based on the percentage of your home used for business. Both direct and indirect expenses are subject to the deduction limit. An unrelated expense is one that is incurred only for the parts of your home not used for business, such as lawn care. This type of expense is not deductible. Below are some examples of how to treat certain specific expenses.

• Real estate taxes. To figure the business part of your real estate taxes, multiply the real estate taxes paid by the percentage of your home used for business.
• Deductible mortgage interest. To figure the business part of your deductible mortgage interest, multiply this interest by the percentage of your home used in business. You can include the interest on a second mortgage in this computation. If your total mortgage debt is more than $1 million or your home equity debt is more than $100,000, your deduction may be limited.
• Rent. If you rent rather than own a home, but you meet the requirements for business use of your home, you can deduct part of the rent you pay by multiplying your rent payments by the percentage of your home used for business.
• Casualty losses. If you have a casualty loss on your home that you use in business, the casualty loss can be treated as a direct, indirect, or unrelated expense, depending on the property affected. Treat it as a direct expense if the loss is on the portion of the property you use only in your business. Use the entire loss to figure the business use of the home deduction. Treat it as an indirect expense if the loss is on property you use for both business and personal purposes. Use only the business portion to figure the deduction. If the loss is on property not used in your business, it is an unrelated expense, and you don't use any of the loss to figure your deduction.

In summary, to qualify for the deduction for the business use of your home, you must meet a two-part test. The first part has three criteria, that is, the use must be exclusive, regular, and for your trade or business. The second part of the test requires you to meet only one of the following criteria: The business part of your home must be:

1. Your principal place of business, or
2. A place where you meet or deal with patients, clients, or customers in the normal course of your trade or business, or
3. A separate structure (not attached to your home) you use in connection with your trade or business.

1. The percentage of your home used for business (business percentage), and
2. The deduction limit.

The business percentage is calculated by comparing the size of the part of your home that you use for the business with the size of your whole house. The resulting percentage is used to figure the business part of the expenses for operating your entire home. Your deduction, if your gross income from the business use of your home equals or exceeds your total business expenses (including depreciation), is 100%. You can deduct all your business expenses. If your gross income from that use is less than your total business expenses, your deduction for certain expenses for the business use of your home is limited.

If you have any questions concerning the home office deduction, or any other tax matter, please feel free to give me a call at (562) 698-9891.

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