Determining Whether You Qualify for Home Office Deductions

Though home-based business owners are more likely to be audited than anyone else, you can protect yourself by understanding and qualifying for legitimate home office deductions. Two tests regulate home office deductions. First, you must determine whether you use the office in a way consistent with the IRS' politics. Just because you leave your law office for the day and work at home a couple of hours each night does not mean that you are entitled to the deductions.

Business owners must use the home office as the principal place of business. This exception to the home office deduction rule applies to artisans, Internet entrepreneurs, direct sales marketers, and others who work exclusively from an office at home. Second, business owners who meet clients in a home office can deduct that office, even if the owner has an office elsewhere. The third of the business purposes exceptions for the home office is a separate structure, such as a converted shed, that is used for business purposes.

Employees, even of their own companies, can qualify to deduct their home office if they meet one of the three prongs of the "convenience of the employer" test. The first prong is that having the home office is a condition of employment. This prong does not apply to owners who treat themselves as employees since it would be a conflict for them to claim a condition of employment. For many telecommuters, however, this prong would allow them to claim a home office deduction because the job requires an office.

The second and third prongs are similar. Prong two states that the employee must need the office to fulfill the functions of the business. The third test asks whether the office is necessary, such as for Internet work that would require space and a computer, for the employee to work. In these situations, one must be able to prove that the job or business necessitates the use of an office space. A door-to-door salesman who uses an office just for filing papers, for instance, may have a hard time proving that the office is necessary for performing the job's functions.

Beyond the function and convenience tests, one can argue for a home office deduction based on more creative factors, such as the distance of the home office from the principal place of business. Whatever argument you use, it is essential to think it out before auditors come knocking.