Home Office Rules
Do you qualify?
To deduct home office expenses, a taxpayer must us the space exclusively and regularly:
- As a principal place of business
- As a place to meet or deal with clients and customers in the normal course of business
- “In connection with” the business if the space is a separate structure, or
- As a place to conduct administrative or management activities of the taxpayer’s business IF there is no other fixed location of the business where the taxpayer conducts substantial administrative activities of the business.
Home office deductions are available to both self-employed taxpayers and employees. However, if the taxpayer is an employee, the business use of the home must be for the convenience of the employer, and the space must be used exclusively and regularly for job-related activities. As a practical matter, it is difficult for employees to pass these tests.
Regular and Exclusive Use
As previously stated, to qualify for a home office deduction, a taxpayer must use the space both exclusively and regularly for the business purpose. Failing to meet either of these conditions results in the disallowance of a home office deduction.
Regular Use. Regular use means the taxpayer must use the portion of the home in the business activity on a continuing basis. Even though the portion of the home is used exclusively (see following discussion) for the business purpose, it will not qualify for the home office deduction if use is only occasional. Thus, a dentist who used his home office to treat emergency patients failed to meet the regular use requirement because the use was only occasional and not to meet with patients in the normal course of his business (Pearson).
Exclusive Use. Exclusive use means the taxpayer uses the portion of the home only for business purposes; there is no other use of the space [Prop. Reg. 1.280A-2(g)(1)]. Two exceptions to the exclusive use rule are (1) storage of inventory or product samples if the home is the sole fixed location of the trade or business, and (2) certain daycare facilities. Space used for these purposes can also be used for personal purposes [IRC Sec. 280A(c)(2) and (4)].
The Cook case illustrates how restrictive the “exclusive use” test can be. In that case, an attorney was denied deductibility for a portion of his residence used as a home office because he failed to meet the exclusive use test. While the residence was in fact the principal place of business for the law practice, the portions used for business were also personally used by the attorney and his family after business hours and presumably on weekends and holidays. Thus, the space used for the law practice failed the exclusive use test and the entire home office deduction was denied.
Multiple Businesses. A taxpayer can operate two or more businesses out of the home office and still meet the regular and exclusive use requirements. However, all such businesses must separately meet the requirements to sustain the deduction (Hamacher). This could be a problem for an employee who uses a home office for employment-related duties and for self-employment (e.g., a sideline) business. If at least one of the activities fails the Section 280A requirements, no home office deduction is allowed for any activity.
EX. Regular and exclusive use — employee with a sideline business.
Joe is a CPA on the staff of a local accounting firm. Joe occasionally brings work home for his own convenience during busy season and uses a room over the garage as an office. He also prepares tax returns on the side and reports the income so generated on a Schedule C as a sole proprietor. Joe meets the Section 280A(c) requirements of regular and exclusive use of the office space for his sole proprietorship. However, since the work performed there as an employee was for Joe’s convenience and not for the convenience of the employer, no home office deduction is allowed.
Principal Place of Business
Of the three uses (noted in the first paragraph of this key issue) qualifying for a home office deduction, the principal place of business test is usually the one most taxpayers rely on. In the landmark Soliman case, the Supreme Court identified two primary factors for determining whether a home office qualifies as the taxpayer’s principal place of business: (1) the relative importance of the activities performed at each business location and (2) the time spent at each place.
The “relative importance” test is analyzed first and, if no definitive answer is reached, the “time” test is considered. In analyzing the relative importance of the activities performed at each location, the point where clients are met or goods and services are delivered must be given great weight. Whether the functions performed at home are essential to the business, while relevant, is not controlling, and the availability of alternate office space is irrelevant.
Note: In Soliman, the Court noted that a taxpayer may have no principal place of business, based on a comparative analysis of business locations. Accordingly, the taxpayer’s house does not become a principal place of business by default.
In Rev. Rul. 94-24, the IRS provided several examples illustrating how these tests will be applied. In addition, the IRS reiterated the Court’s finding in Soliman that, in some cases, application of the relative importance and the time tests may result in a determination that a taxpayer has no principal place of business for home office deduction purposes.
Example 8E-2 Failing the principal place of business test—multiple business locations.
Harold Howell is a self-employed plumber who spends about 40 hours a week at customer locations and an additional 10 hours per week in his home office talking with customers, reordering supplies, and reviewing the books. In addition, a full-time unrelated employee works at Harold’s home office performing administrative tasks such as scheduling appointments and keeping the books. Does Harold’s home office qualify as his principal place of business?
No. Under these facts, Harold’s home office is not his principal place of business. Although the tasks performed in the home office are essential to the business, the work performed at the customer locations is relatively more important (Rev. Rul. 94-24).
EX Home office qualifies as principal place of business.
Wendy Booker is a self-employed writer who spends about 35 hours each week in her home office writing and an average of 15 hours per week at other locations doing research, meeting with publishers, and attending promotional events. Does Wendy’s home office qualify as her principal place of business?
Yes. Under these facts, Wendy’s home office is her principal place of business. Her activities away from her office are less important and take less time than her writing, which is the essence of her trade or business (Rev. Rul. 94-24).
Preparation Pointer: Two auxiliary benefits of qualifying for a home office deduction under the principal place of business test are the ability to deduct additional transportation costs and the more favorable rules on depreciating computers used in the home office. Generally, expenses incurred for transportation between a taxpayer’s home and regular place of business are personal, nondeductible expenses. However, when a taxpayer’s home office qualifies as the principal place of business under IRC Sec. 280A(c)(1)(A), a trip from home to another business stop is not a personal commuting expense. This appears to apply even if the home office deduction is not allowed (e.g., home office is principal place of business but space is not used exclusively for business). (See Key Issue 12G for additional discussion of deducting local transportation costs.) Computers and peripheral equipment are no longer considered “listed property” if used exclusively in a business conducted in a qualifying home office [IRC Sec. 280F(d)(4)(B)]. Therefore, a taxpayer is more likely to qualify for claiming a Section 179 deduction or faster depreciation write-offs for business computers. (See Key Issue 15H for more details on depreciation of computers.)
Client Advice: To qualify for the home office deduction, the office does not need to be the taxpayer’s principal place of business if he (1) uses the office regularly and exclusively to meet and deal with clients or (2) it is a separate structure not attached to the house and used regularly and exclusively in the business. Taxpayers who cannot meet the principal place of business test might consider restructuring their businesses to meet one of these tests. However, taxpayers who do not meet the principal place of business test cannot deduct travel from their homes to another business even if their homes qualify for the home office deduction under one of these other tests.
TRA ’97 Broadens Definition of “Principal Place of Business.” Effective for tax years after 1998, TRA ’97 expands the definition of “principal place of business,” so a home office deduction is allowed if (1) the office is used by the taxpayer to conduct administrative or management activities of the taxpayer’s business, and (2) there is no other fixed location of the business where the taxpayer conducts substantial administrative activities of the business [IRC Sec. 280A(c)(1)]. The new definition effectively overrules the Soliman decision, allowing many more taxpayers to meet the definition of “principal place of business.”
Caution: Despite the change in the definition of “principal place of business,” there is no change to the “regular and exclusive use” tests discussed earlier. Thus, taxpayers who qualify for the expanded definition of “principal place of business” beginning in 1999 must still meet the regular and exclusive use tests.
Important note: This is a summary, and as such, it is not intended as a complete explanation of
all applicable situations. Many exceptions, definitions, and special rules in the law have been paraphrased, simplified, and/or omitted. Readers should not take specific action based on this summary without first consulting the statute and regulations or seeking advice from a qualified professional.
Information in this material is for general purposes only. You should consult Sechrest & Bloom, LLC
at 978-263-7771 for specific recommendations about your particular situation.
This article was supplied or updated on October 4, 2005.
