AUDIT FEAR

Have you been avoiding taking an office-in-home deduction all these years because you kept hearing what a red-flag this is? Have you been reading that this deduction will almost definitely attract an audit? Has TaxMama been telling you nonsense like this?

Well, it was true. The IRS could run a program through their computers and search for people who were taking the office- in-home deduction and, almost certainly, come up with a great many audit changes. Why?

Until the end of 1998, the rules for office-in-home were dictated by the results of a court case that a Dr. Suleiman lost. He was a physician whose work took place in a hospital. But he did have a legitimate office at home where he took care of all of his business transactions, planning, calling, and maintained his records. However, because he did not meet with patients at home, under a strict definition of the tax code, he could not have a deduction for an office at home.

Pathetic, isn't it? Since the same definition applied to people like plumbers (they didn't fix their customers' pipes by bringing them to their own home and working on them there...), laundromat owners, traveling salesmen (a whole other problem), actors ... you're getting the idea.

So, looking at these people's returns, odds were in the IRS's favor to score some good money by auditing office-in- home returns. Not any more.

INCENTIVE'S ALL GONE

Under the rules that took effect as of January 1, 1999, (based on a law that passed two years earlier ... why it took so long, I have no idea!) you no longer have to be meeting customers in your home.

Publication 587

1. Your use of the business part of your home must be:

a. Exclusive (however, see Exceptions to Exclusive Use, later),
b. Regular, 
c. For your trade or business,

2. The business part of your home must be one of the following:

a. Your principal place of business,
b. A place where you meet or deal with patients, clients, or customers in the normal course of your trade or business, or
c. A separate structure (not attached to your home) you use in connection with your trade or business.

Oh, there's no doubt that many people who are taking the deduction are not really entitled to it. But, it's no longer a sure thing. So, this will go down on the IRS' list of audit priorities for the 1999 reporting year and beyond.

INNER SPACE

So, we're determined to take the deduction ... how much of the home do we get to deduct?

If you measure out the square footage of the space(s) you use carefully, you will find that, if you really are working at home, you use substantially more of your home for business than you realize. After all, most business people use their car for more than 50% business. Have you ever noticed how much space your garage takes up? While you may have a 1400 sq ft home, your two-car garage may add 800 sq ft. (about 20' x 40') - if half of that is used for your 75% business-use car - that means 300 sq ft (800 x 50% x 75%) - add to that the storage for all your files, inventory, tools and records (about 10 x 20 sq ft) - that's another 200 sq ft. We've just found 500 sq ft in the garage alone!

Now let's look at the space you're using in the house. OK, you have that area at the back half of the living room. You have a desk (or two to make an L-shape), a bookcase or three, a cabinet for your printer, several upright or lateral files ... let's say you're taking about 12' x 15' = 180 sq ft. But you have a closet filled with office supplies - another 6' x 4' = 24 sq ft. So far, we have 704 sq ft! (24+180+500) divided by the total square footage of the house and the garage (1400+800) of 2200 sq ft nets us 32% of the home.

Had we just stuck with your unimaginative desk area, you'd have had 180/1400 = 12.9%.

As long as the areas you're taking for the deduction are really used for business, you will have no problem in an audit.

PROVE IT, BABY!

The problem, though, is - if they do audit you, it will be about 2 or 3 years after the year you used the area. You might have moved or remodeled by now. So, how do you protect your deduction? Simple. Photographs. Take lots of pictures of the office spaces in the house. Remember to include the closets and storage areas. Take photos of the garage area and any business space out there. If there is any other place on your property that is strictly used for business, shoot that, too!

T-TIP! If you make money by buying and selling your homes frequently, stay out of the office in home arena.

So, you're at home with the idea of having an office in home. Now, the question arises, should you use it? There may be times when it's wise to just skip it.

DECISION-MAKING TIME

I'm going to tell you some of the considerations I look at for my clients:

* Do you own or rent your home? 
* If you own, will you still be living there two years from now?
* How soon DO you plan to sell it?
* Will you have a gain or a loss if you sell it?
* Do you expect your business to show a profit, after using these deductions?

A CASE: THE PUBLISHER

Recently, I prepared about 7 years worth of returns for someone who was renting an apartment. As a publisher, she did all her work from home - and a substantial portion of her home really was devoted to her business.

She had losses for the first 6 years - which she could demonstrate were supported by some very high credit card and bank loan balances. At first, I didn't use the office in home deduction - I put it aside. But when I got to the last year, she had about $50,000 worth of profits. Suddenly, all those years when I could have carried the losses forward into this return became very attractive. (I love it when I can see the future, like this, don't you?)

When I brought in all the office in home losses from the last six years, they reduced her current year's (SE) self employment tax to practically nothing.

I was not concerned about her income taxes because she had enough NOL (net operating losses) from the prior six years to eliminate any income taxes. But NOLs don't affect your SE tax, which is 15.3% of your business profit for the current year.

Using these carried forward home office expenses gave her two benefits:

* One immediate - about $5,000 savings on SE taxes
* One future - we didn't need to use about $35,000 of the current NOL and were able to keep that available for more prosperous years