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Home Office Loopholes

By Diane Kennedy

Most likely every small business has a deduction that's right down the hall. Yet, many people don't take this deduction because of fear or misinformation. That missed deduction: a home office.

Home Office History

The problem with legitimate home office tax deductions came about in the early 1990s when the Supreme Court made a landmark ruling that was unfavorable for the home office deduction. This case, known as the Solomon decision, stated that an anesthesiologist could not take a deduction for his home office, even though it met all of the normally-required criteria. In this case, the deduction was disallowed by the IRS and upheld by the Supreme Court because Dr. Solomon did not earn his income in his office. As an anesthesiologist, he earned his income from working in the hospital. His home office was necessary for maintaining records but it was determined that was not sufficient enough reason to take the deduction.

The Congress Changed the Law!

The new test for a home office is pretty simple: The requirement is that the office must be used exclusively for business. That means you can't deduct a corner of your living room. But if the room IS. used for business exclusively, it's a deduction. The "old rules" -- requiring separate entrance, etc -- are gone.

Home Office Loopholes

  • If your business is in the form of a C-Corporation, the C-Corp can pay you a fair market rent for the use of the space.

  • If your business is in another business structure type, the business can deduct a pro-rata portion of the business percentage of the home

  • C-Corporation Rent

If you operate your business as a C-Corp, office rent becomes an easy (and profitable) calculation. Here are the easy steps in taking a legitimate tax deduction:

  1. Contact realtors or check the paper in your area to determine the market rent. Since your space will include expenses such as property tax, common area maintenance and utilities, make sure the rent you are quoted is considered a "gross" rental price.

  2. Calculate your square footage at the exclusive business-use area.

  3. Multiply the gross square footage by the business area.

  4. Document the square footage (using a house plan or photo of the room) and begin paying the calculated amount on a monthly basis.

  5. This is a deduction for the corporation...but ALSO income for you on your personal tax return. Off-set this rent by a pro-rata portion of the regular home expenses.

Pro-Rata Deductions

If you operate in a business form other than a C-Corporation, you will deduct the actual costs of your home, pro-rata, based upon how much business square footage you have. Here's how to do that:

  1. Measure your business square footage.

  2. Measure the total square footage of your home.

  3. Divide (1) above by (2).

  4. Document the square footage (using a house plan or photo of the room) and begin paying the calculated amount on a monthly basis.

  5. This fraction now becomes the percentage that is applied against all "indirect" home business costs. These "indirect" business costs are the same that are used in (5) above to offset the rent received by you if you operate your business as a C-Corporation.

Your home office is a valid and legitimate tax deduction. Use it -- the rich do!

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