Consider that home office deduction

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By: JIM VANDER SPEK - For the North County Times on February 14, 2003

An office in the home is a necessity for some and a luxury for others. I read once that the San Diego area had more home-based offices than any other in the United States. Whether you believe that factoid or not, we do know that thousands of professionals, contractors and others operate their business from their homes here in Southern California. We also know that the tax implications of owning your office in your home and claiming a home-office deduction are significant.

One huge impact is that a proportion of home interest and taxes could become deductible for Social Security and Medicare taxes, as well as for income taxes. This is because your home-office deduction will decrease your business income. Additional deductions include utilities and other household expenses. Also, you should not forget that your business auto mileage increases because your trips begin at your doorstep.

Our government has had mixed feelings about HODs for a long time. The Supreme Court a few years ago gave the IRS a huge victory and stopped many professionals from claiming a HOD. Congress gave that one back.

Still, many taxpayers avoid the HOD for several reasons. First, they think it will cause their returns to be audited. This is unfortunate. HODs are perfectly legitimate and clearly deductible when the proper conditions apply. Why not take every legitimate deduction? There is even a special form that works out most of the calculations. Besides, audits are few and mostly random, anyway.

The most compelling reason not to claim an office in your home has been that it could expose a portion of your gain to capital gains taxes when you sell. Let's say that your home office is 10 percent of your home. When it comes time to sell, 10 percent of your gain could become taxable since it is used for business, not as your residence. I have even advised some taxpayers to give up their HOD after a few years so that they fall under a two out of five years safe harbor rule, eliminating this danger.

This reason has now suddenly disappeared. In an unexpected, stunning move, the Internal Revenue Service has now ruled that claiming an HOD will not subject that portion of the house to capital gains taxes. The only portion that remains taxable, which is not usually significant, is the cumulative amount of depreciation that you have already claimed. The primary prerequisite is that the office must be a part of the home, not in a separate building. With this new ruling, we can expect more people to claim an HOD and receive the tax deductions to which they are entitled.

How do you know if you qualify for a HOD? Basically, the office needs to be the primary office, not a second office. Also, the space must be used exclusively for your business on a regular basis. The rules also do not allow most of your expenses if your business is unprofitable.

Jim Vander Spek is a certified public accountant with offices in Escondido. Contact him at Jimv@vanderspekcpas.com