Tax alert! The IRS has a surprise for home-office workers: a lengthy new tax form for calculating the home-office deduction

Tax alert! The IRS has a surprise for home-office workers: a lengthy new tax form for calculating the home-office deduction – includes related article on tax tips

Linda Stern

The Internal Revenue Service has some good news and some bad news for the four million taxpayers who take a deduction for a home office. The bad news is that we will have to file a new form with our 1991 tax returns: A form that the IRS estimates will take us an hour and a half to comprehend, complete, and post. A form that will have us crawling around our homes with yardsticks, looking up old real estate tax records, and figuring out how much our property would be worth without our houses.

Believe it or not, there may be some good news hidden in all this, since these are all calculations we were supposed to be doing anyway. And the new Form 8829, “Expenses for Business Use of Your Home,” promises to walk us through the calculations step-by-step, simplifying and clarifying the home-office rules to the point where some of us may actually save money by taking overlooked deductions.


All this doesn’t mean the IRS was trying to save us money when they drafted this form. Rather, it was created at the request of the service’s examination department, where auditors kept finding “errors” in the returns claiming the home-office deduction. Specifically, taxpayers kept using home-office deductions to create tax losses in their home-based businesses. That’s a no-no. IRS rules hold that the home-office deduction can be carried over from years when there is not enough money to years when there is enough to support the deduction. But home-office deductions cannot create a loss.

Until now, IRS officials couldn’t really tell how much of a business’s expenses were home-office related. The home-office deduction was just a check-off box on Schedule C, the form sole proprietors (most home-based business owners) file to report their business income and expenses. Specific home-office expenses were classified in different Schedule C categories, where they were mixed with other expenses. The IRS couldn’t tell just how much of the deductions were derived from the home office, so the service couldn’t tell when a taxpayer was taking more than his or her due. In cases where there was a loss, the IRS couldn’t tell without an audit whether the home-office deduction had contributed to that loss.

“With all the computations together on one form, rather than just scattered on the Schedule C, it will be easier to review,” said an IRS spokesman. “We hope that [with the new form] we will have less examination activity in the area because we will have more accurate returns, but we don’t know exactly how that will play out.”

Ron Draper, a tax partner in the Minneapolis accounting firm of McGladrey & Pullen, thinks he knows how it will play out. “There’s no doubt it will create a bigger red flag for audit. I don’t think they are doing it just to be helpful to the taxpayer.”


But fear of audit is no reason not to take the home-office deduction, which can be sizable.

“I don’t think we should play the risk-of-audit game,” says Draper. “You should always claim every deduction you are rightfully entitled to.”

It is a legitimate deduction, and for good reason: When you give up a part of your home for a business office, you really do give up a part of your home.

In our house, for example, my husband and I both use separate rooms for our home offices. In a house that might be considered midsize, we don’t have a family room or a guest room. When relatives come to visit (not an infrequent occurrence here on the edge of Washington, D.C.), my kids double up and one sacrifices his room for the guest. Our television–play area–hand-around room is the living room, which is never in the pristine condition of living rooms in other homes. And I would really like to have a Ping-Pong table or a pool table, but we don’t have the space, what with all the desks, computers, filing cabinets, and piles of paper. I’m not complaining–the work-at-home lifestyle makes us all very happy. But a real home office is a sacrifice of space, and that’s why it presents some legitimate tax deductions.


You are rightfully entitled to a home-office deduction if your space passes this test: It must be used exclusively as a principal place of business or as a place where you regularly meet clients, patients, or customers. It does not have to be a separate room; it can be a distinct area of another room, as long as it is set apart and reserved exclusively for your business.

And to what deductions does this office entitle you? One you’ve met the legitimacy test, you can deduct a prorated portion of your mortgage interest, home maintenance, insurance, and utilities. In addition, if you own your home, you can deduct a portion of your home’s value, depreciating it every year that youuse your home office. If you rent your home, a prorated portion of your rent is deductible in place of mortgage interest.


The new form will clear up much confusion about the mechanics of figuring your home-office deduction. It gives you a fair amount of leeway in terms of determining your business percentager of home use: You can use square feet, number of rooms, or “any other reasonable method” of comparing your office space to the total space available in your home, according to the new instructions.

When you are depreciating your house, the form describes exactly how you separate the home’s land value from its building value: Only a percentage of the latter is deductible.

And this is how the new form may save you money: It allocates home-mortgage interest and real estate taxes (which are deductible even if you don’t have a home office) between your personal income taxes and your business taxes. Deducting as much of these expenses as possible from your business makes sense; there the deductions offset the 15.3 percent self-employment tax as well as the income tax. While this is a deduction you’ve always been allowed to take, many people have erroneously taken their mortgage-interest and property-tax deductions against their personal taxes, not realizing that classifying them properly can cut their tax liability.

Finally, all the information you plug into Form 8829 coalesces into line 34, “Allowable expenses for business use of your home.” That figure gets transferred to your Schedule C, line 30. The IRS will be able to quickly see how big your deduction is.



There is one situation in which it is not advantageous to take the full deduction. That’s for homeowners who intend to sell their homes while the home office is in use. According to IRS rules and tax law, if you have depreciated a portion of your home as a business expense, and you then sell your house for a gain, you have to pay a capital-gains tax on that portion of the home that you depreciated. The IRS calls that “recapture,” and it means you aren’t allowed to delay those taxes by rolling over the whole gain on your home into your new house, as you would if it were strictly a residence and not a business.

This doesn’t affect renters. If you rent your home, you are in the clearest position to benefit from the home-office deduction and can continue to deduct rent, utilities, and insurance until the day you move out of your house or apartment.

If you are a homeowner intending to sell your home, there are two ways to go: You can continue to take deductions for utilities, mortgage interest, and taxes but stop depreciating the house. Or you can stop using your home office as an exclusive and principal place of business and give up the deductions altogether. For example, you could put in a sofa bed and invite my relatives for a visit. My son wants his room back.

LINDA STERN, HOME-OFFICE COMPUTING’s financial columnist, has takken the home-office deduction for six years.

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