ELITE ADVISOR BEST PRACTICES

Maximize Deductions by Making the Home Office the ‘Principal Place’ of Business

An office inside the home may qualify for the home-office deduction even if your client has an office for the same business outside the home.

By Glenn Demby

Key Takeaways:

  • An office inside the home may qualify for the home-office deduction even if your client has an office for the same business outside the home.
  • The best way to qualify for such a deduction is for the client to make the home office her “principal” place of business.
  • Explain to your clients the standard the IRS uses to judge if the home office really is a principal place of business.
  • Tell your clients to keep scrupulous records documenting their compliance with each of the three elements of the principal place of business standard.

What did your client do wrong?

Your client, Dee Duckshin, operates her small business from a downtown office; she also spends 15 hours a week doing administrative tasks for the same business in a home office that takes up 1,000 of the 4,000 square feet in her home. After Hurricane Mandy blows the roof off her house, she spends $40,000 on repairs, and another $10,000 to fix hurricane damage to the downtown office. She claims deductions for only the latter repairs.

Question

What did Dee do wrong?

Answer

Dee should have also claimed another $10,000 (25 percent of the $40,000) of her costs in repairing the roof as a home-office casualty loss deduction.

The Moral

Office space inside the home can qualify for a home office deduction even if your client has an office for the same business outside the home. The best way to qualify for such a deduction is for the client to make the home office her principal place of business.

What your clients probably believe

I’ll bet a lot of your clients share the misconception so common among small-business owners that a home office is not deductible unless it’s their only place of business.

What the Tax Code really says

Repairs and other costs of maintaining a home are normally considered nondeductible personal expenses. Exception: Clients can deduct costs allocable to a portion of the home used (1) “exclusively,” (2) “on a regular basis” and (3) as their “principal place of business.” Let’s look at the three requirements your clients must meet to get the deduction.

Requirement 1: Exclusive use

“Exclusive use” means clients must use a specific area of the home, i.e., a room(s) or other “separately identifiable space,” only for their trade or business.

Example

An Illinois attorney used the dining room of his house as a conference room to host clients. He and his family also dined in the room on weekends. Result: The tax court upheld the IRS’ decision to deny him a home office deduction for the room for not meeting the exclusive use requirement.

The IRS tends to treat exclusive use like pregnancy—either one or the other with no in-between. Luckily, the tax courts take a more liberal approach and carve out some middle ground.

De minimis personal use is OK. Your client won’t flunk the exclusive use test if the personal or mixed use is de minimis, i.e., minor to the point of insignificance. The problem is that de minimis is a subjective standard that varies from case to case. Consider the following examples:

Requirement 2: Regular use

The client must also use the office on a “regular” basis. “[I]ncidental or occasional business use” is not regular use, notes the IRS. Regular use means “on a continuing basis.” Examples:

  • New York Times editor’s use of home office to hold an average of one conversation per night with politicians, labor leaders and other public figures; and
  • Account executive who is required to field client calls, but who can’t be reached during the day, takes calls at his home office on average 2.25 hours per night for five nights a week.

Rule of thumb: Ten or more hours per week should be enough to establish regular use. But also tell your clients that “use” means all business activities, not just administrative tasks.

Requirement 3: Principal place of business

Principal doesn’t mean “exclusive.” The IRS uses two criteria to determine if the home office is the principal place of business:

1. The client must use the office “regularly and exclusively for administrative or management activities” related to the trade or business. Examples:

  • Billing customers, clients or patients
  • Keeping books and records
  • Ordering supplies
  • Setting up appointments
  • Forwarding orders
  • Writing reports

2. The client must have no other fixed location where he conducts such administrative or management activities. The IRS lists examples of activities that aren’t disqualifying, including:

  • Having others conduct administrative or management activities at locations other than the home (e.g., hiring another company to do billing for the client’s business at the billing company’s location)
  • “Occasionally” conducting “minimal” administrative or management activities at a fixed location outside the client’s home
  • Conducting “substantial” non-administrative or non-management business activities outside the home (e.g., meeting with customers at outside locations)
  • Choosing to conduct administrative or management activities at home even though the client has suitable space to conduct them outside the home
So what should you do about all of this?

Too many small-business owners who operate out of a home and at least one other office miss out on tax savings because they don’t understand how the home office deduction works. So sharing the above knowledge is bound to win you lots of appreciation. But you also need to caution clients—assuming they do qualify—that the IRS is very strict and that they shouldn’t claim the home office deduction unless they keep scrupulous records documenting that they meet all three prongs—exclusive use, regular use and principal place of business—necessary to qualify for it.

This article was adapted with permission from MurrayBradfordTaxInstitute.com, a site dedicated to helping self-employed taxpayers and one-owner businesses save on taxes.


About the Author

Glenn Demby is an attorney and prize-winning B2B journalist who specializes in explaining the law in plain English and providing how-to solutions to help business professionals overcome their compliance challenges. He can be reached at 203-354-4532 and at glennsdemby@gmail.com.