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Home office tax deductions hinge on details, good record-keeping

  • Story Highlights
  • Number of taxpayers claiming home office deductions doubled from '91 to 2005
  • Some experts say the deductions might not add up to much savings
  • If your home office does meet the IRS criteria, you could get a break on your taxes
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By Helyn Trickey
Special to CNN
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PORTLAND, Oregon (CNN) -- Home may be where the heart is, but for millions of at-home workers it might be where the tax deductions are, too.

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Just because you have a home office doesn't mean you can claim it as a deduction on your taxes.

The number of U.S. taxpayers claiming home office deductions has grown from more than 1.5 million in 1991 to nearly 3.2 million in 2005, the most recent tax year for which figures are available, according to the Internal Revenue Service.

The dollar amount Americans claim each year is also climbing -- from nearly $3 billion in 1991 to close to $9 billion in 2005, the IRS said.

The number of sole proprietorship businesses -- a tax classification that includes home-based businesses -- also has shown impressive growth, increasing in number by nearly 50 percent in the last 15 years, the IRS reports.

While trading in a harried morning commute for a short trip down the hall sounds inviting, claiming home office space tax deductions can be tricky. See I-Reporters in their home offices »

"When you step into this new land of self-employment and telecommuting, you can get yourself into lots of trouble," said Michael Davidson of A. E. Tax Service in Portland, Oregon.

"Fifteen years ago, if you [claimed] a home office on your return you might as well say [to the IRS], 'Hey, I'm here. Come and get me.' But now it's much more common," Davidson said.

Home office tax facts

When should I claim a home office deduction?

When your home office is large enough to mitigate the cost of the tax paperwork it takes to claim the space. Some tax experts recommend the home office be 20 percent or more of your home.

When you telecommute at the convenience of an employer, not yourself.

When your home office is used only for business purposes and it is used often enough to maintain that business.

When you're self-employed and your tax deduction is not more than what you make in your business.

What tax forms should I use?

If you're an employee and would like to itemize deductions, use Form 1040, Schedule A to claim expenses.

If you're self-employed, use Form 8829 to figure your home office deductions and report them on Form 1040, Schedule C.

If you're in the business of farming or are an employee, use Publication 587 (Business Use of Your Home -- including use by daycare providers) to itemize your deductions.

Maggie Doedtman, manager of advice delivery at H&R Block, agrees.

"The idea that claiming [a home office] is a red flag for the IRS is kind of an urban legend," she said.

"With telecommuting becoming more and more popular and Internet-based businesses popping up all over the place, [claiming a home office] is more the norm. If you're entitled to a deduction, by all means claim it."

Davidson and Doedtman are enrolled agents, who -- like certified public accountants and tax attorneys -- have broader abilities to represent taxpayers during a federal audit than regular tax return preparers.

Davidson advises seeking tax guidance from any one of them before tackling a home office deduction on your own.

But is claiming a home office deduction always worth it?

Stanley Nichols, a semi-retired CPA who does tax work for clients from his own home office in Houma, Louisiana, cautions that the deductions might not add up to much savings.

"It all depends," he said, "You have to decide how much square footage you'll devote to a home office, and if you come up with a minute amount -- less than 10 percent of the total footage of your home -- it might not be worth the trouble."

Nichols advises home-based workers to commit 20 percent to 25 percent of the square footage of their home to office space that they use exclusively for work.

The IRS uses three main tests to determine if a taxpayer is eligible for home office deductions, according to Doedtman.

First, the home office must be used regularly -- not necessarily full time but enough time to maintain the business. Second, the home office must be used exclusively for work.

"The exclusive rule is very strict. If the kids play on your computer or you surf the Internet, it won't work for the IRS," she said.

Third, a commuter may only claim a home office if the space is used for the convenience of the employer, not the employee.

"You have to be sure the employer can't provide an office space," Davidson said, speaking from Portland. "Out here there are lots of graphic designers who work for Nike, and many of them would like to work out of their homes, but because there's a huge Nike campus with room for them ... they don't get to claim the home office."

So, if these criteria are met, how much can taxpayers deduct for the business use of a home?

According to the IRS, taxpayers should divide the square footage of their home office by the total square footage of the home.

This percentage is what taxpayers can apply to expenses they plan to deduct, such as utilities, home repairs -- office repairs are total deductions -- business-related mileage, pest control, furniture, home security and office equipment. With equipment, take the depreciation over five years or write it off completely in one year.

"You can even write off your dog if you can prove it's kept for security," said Davidson, half-joking.

But be careful. Some bills that seem like natural deductions are not. For instance, the first phone line into a home always is considered for personal use.

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The key for taxpayers hoping to claim deductions is in good record-keeping.

"It's better to make a note on each receipt -- dinner with a particular client -- make that note at the time you get the receipt," Doedtman said. "I dump them in a desk, and every year on New Year's, as I'm watching football, I take them all out and categorize them. My system works well for me." E-mail to a friend E-mail to a friend

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