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Use Caution when Taking Tax Deductions for Business Use of Your Home

It’s that time of year when small business tax preparation is a hot topic, and the small business bookkeeping pros at PADGETT BUSINESS SERVICES® field a lot of inquiries about IRS rules and regulations. Entrepreneurs who run home-based businesses often have a lot of questions about what they can and can’t deduct as a business expense.

Working from home is the dream of many people, but you could eventually face an IRS audit nightmare if you don’t understand the rules pertaining to home business deductions. Like all small businesses, owners of home-based businesses need to minimize their tax burden by taking advantage of all allowable deductions, but you should be very careful to make sure that you’re entitled to any deductions that you claim on your tax return.

Unfortunately, some home-based entrepreneurs unknowingly take deductions that IRS rules don’t allow. This can lead to an audit and actions by the tax agency to recover any unpaid tax, as well as additional penalties and interest. Home-based businesses tend to get increased scrutiny from the IRS because of the relatively high rate of errors that its examiners see on the returns of this type of taxpayer. Thus, if you do make a mistake, it’s unlikely that it will fly under the IRS’s radar.

The biggest way that proprietors of home-based businesses get into tax trouble is by taking a home office deduction that they don’t qualify for. You can deduct a portion of the costs of your mortgage or rent payments, utilities, real estate taxes and other costs of maintain your home, but only if you are truly running a home-based business. To get such a deduction, IRS rules state that your home must be your company’s principal place of business, and that you must be using a part of your residence “regularly and exclusively” for your business.

In other words, you can’t take a deduction for a room out of which you are running a business, but that you also use for hobby activities and entertaining friends. The room in question fails the test of exclusivity.

On the other hand, say that you have a den at home that you do use solely as a place to catch up on your business’s paperwork and to store business records. However, your activities at your home office just support your main business operation – a small retail store located in a strip mall. In this example, you wouldn’t qualify for a home office deduction, because clearly your storefront, not your home, is your principal place of business.

If you have a home office or workshop that does meet the all IRS tests – that is, you use it regularly and exclusively as your principal place of business – you should be able to deduct a percentage of your home expenses. This percentage is usually based on the percentage of your home’s total floor space that your business occupies. Remember, too, that you don’t have to own a house to take this type of deduction. You can be an apartment dweller, reside in a mobile home or even live on a boat, for that matter! Just as long as your residence is a place where you can sleep and cook, and as long as the portion of it that you use for business meets all of the qualifications discussed above.

When you’re working to comply with the maze of tax laws that faces small business owners, it’s best to get the help of a seasoned tax professional. For more than 40 years, PADGETT BUSINESS SERVICES® has provided tax advice and tax preparation assistance to small businesses along with services such as payroll processing, bookkeeping, financial planning, financial reporting and consulting. 

We encourage you to contact us with any questions.

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