Follow Home Office Rules and Avoid IRS Red Flag

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The single biggest misunderstood tax deduction is the home office. Do it right and you’ll get a big tax deduction. Do it wrong and you can face an IRS audit.

There are only two requirements for the home office: (1) The space used must be exclusively used for business, and (2) The space must be regularly used for business purpose.

It’s okay to have another location for your business. It’s okay if you never have customers visit you in the room. You don’t need a separate door for the business. Those are all old rules. The new rules are clear: exclusivity and regular use. Period.

To take the deduction, measure the room size. Now compute your total house square footage. Divide the business portion by the total square footage. That percentage is then used against all “indirect” house costs such as mortgage interest, homeowner’s dues, utilities, insurance, janitorial, repairs and the like. If you have expenses directly attributed to the home office, you get 100% of that deduction. So, that would include items like redoing the flooring in your office or converting your closet into a storage space.

The home office deduction is then taken directly against the business income. If it forces you into a business loss, you have to suspend the loss. Don’t let that stop you from taking the loss, though. I just had to explain to a client who did that last year (didn’t bother to take the home office deduction because he already had a loss). This year he had income of over $100,000 and he wanted to take the missed deduction this year. Problem is that it would mean an amended tax return, extra cost and unwelcome IRS scrutiny. If he’d just taken it and “suspended” the loss last year, it would have been used this year.

IRS AUDIT PREVENTION: Take a picture of the home office space. That way if you are ever questioned, you can immediately provide proof of the home office. You might be surprised how fast an audit disappears if you do this one simple thing.

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