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Working at home can create quite a tax shelter, at least until it
comes time to sell your home and its office.
First, if your home office qualifies
for a tax deduction, you must calculate the amounts you are
entitled to deduct on IRS Form 8829, "Expenses for
Business Use of Your Home".
You file the form with your income tax return.
To determine how much you can deduct, measure the number of square
feet used for your home business and divide that by the total square
feet of living space in your home. The result is the percentage of
your home you use for your business. It determines how much of your
rent, depreciation, insurance, utilities and other related expenses
you can deduct.
Nolo.com,
the Berkeley, CA-based legal self-help publisher, says, if you are a
renter, simply multiply the percentage by your annual rental payment,
renters insurance and utilities to determine how much of each expense
to deduct.
Likewise, if you own your home you use the percentage to figure
your deductions. However, you must figure the deductions based only on
the structure, not the land portion of the value. Your assessor can
tell you how much your home is worth and the value of the land.
Take the deduction against the value of the home by depreciating
the value over 27.5 years, if the business started during the years
1987 to 1993. Since 1994, the home value is depreciated over 39 years.
If your business began before 1987, you use what's called
"straight-line" depreciation, based on the estimated useful life of
the property.
In any event, the amount of your home office deduction cannot be
greater than the profit generated by your home-based business.
On Form 8829 you must separate all of your home-business expenses
into two categories, "direct" and "indirect" expenses. Your home
office area is a direct expense. Other costs, utility bills,
insurance, etc., are indirect expenses.
You get a full tax deduction for anything spent exclusively for
your home office, including equipment, equipment insurance,
decorating, modifying, furnishings, maid service and the like.
"People forget. All the office expenses, pencils, pens, your
office equipment, entertainment for business purposes. Travel to and
from your home on work-related trips. The car mileage, legitimate
business travel. Just keep records," said Bruce Hahn, president of the
non-profit American Homeowners Foundation in Arlington, VA.
For the tax savings on indirect expenses, you apply the percentage
of your home used for your business to household utilities, repairs,
taxes, homeowner's insurance and the like.
Basic telephone service to your home is not deductible.
Business-related long distance charges or a second phone line
dedicated to your business are.
Unfortunately, the home office deduction isn't all roses.
Nolo.com says for home sales after May 6, 1997, you owe a
"recapture tax" on the depreciation deductions previously taken on the
business portion of your home. That means you pay back some of the tax
savings and you cannot use the $250,000 per person home-sale profit
exclusion to offset the recapture gain.
In other words, if you took a total of $15,000 in home office
depreciation deductions over the past ten years, you will be taxed on
$15,000 when you sell your home -- profitably or not.
That's a loophole closed by the Taxpayer Relief Act of 1997. Until
then you could avoid paying the recapture tax if you stopped working
from home long enough before you sold it. The law doesn't apply to
renters, because they don't own their homes.
"When you sell your home you have to 'recapture' or give back a
portion of the money, but the idea is that you'll be in a lower income
tax bracket then," said Hahn.
Editor's Note:
This is part two of a two-part series. To go to the first half of this special installment,click here. |
