As a realtor, you may often be asked about the home office rules. Tax law changes in recent years have made it easier and more beneficial for your clients to claim this deduction.

Andrew D. Schwartz, CPA, who is the editor and major contributor to Real Estate Pro Taxes, a website that provides income tax and financial planning information geared towards real estate professionals, provides us with some information on claiming the Home Office deduction...

The risk of claiming the home office deduction on your tax return remains an issue of debate. Many taxpayers and tax preparers believe the home office raises a red flag with the IRS. Even so, you should make an informed decision about whether to claim this valuable deduction, as many of the recent tax law changes involving the home office rules have benefited the taxpayer.

Two Beneficial Changes

Prior to 1999, many people did not qualify for the home office deduction. That's because you were required to perform the "income producing activity" within the home office to be eligible. Doctors had to see patients, lawyers had to meet with clients, and realtors could only make their sales over the phone.

Everything changed, effective in 1999. As long as you use a portion of your home, regularly and exclusively in connection with your trade or business, you now qualify to claim the home office deduction.

For renters, this was great news. Since rent isn't otherwise deductible on your federal tax return, being able to claim the home office deduction made a portion of your rent tax deductible.

For homeowners, however, there was a potential pitfall when you sold your home. Assuming you sold your home for a gain, you would generally be taxed on the portion of your home that you claimed as your home office. This pitfall caused many homeowners to forego this deduction.

A recent tax law change eliminated this pitfall. Under the current rules, if the office is located within your home (and not a separate structure on your property), you will no longer be taxed on the portion of the gain attributable to your home office when you sell your home. All you need to do is pay taxes on the depreciation you claimed over the years.

Additional Tax Breaks

Claiming a home office also limits the impact of the dreaded Alternative Minimum Tax (AMT). While your real estate taxes are allowable as an itemized deduction when calculating your "regular" tax liability, they don't count when calculating the AMT. However, the portion of your real estate taxes allocated to your home office are not limited by the AMT if you're self-employed.

And if you have more than $1.1 million of total mortgage debt outstanding on your principal residence and vacation home, your mortgage interest deduction is capped. By claiming the home office deduction, you'll deduct a portion of the excess interest as part of this deduction.

Are You Eligible?

To claim the home office deduction, a portion of your home must be used regularly and exclusively in connection with your trade or business. According to the IRS, "to qualify under the exclusive use test, you must use a specific area of your home only for your trade or business (including for managerial and administrative tasks). And to qualify under the regular use test, you must use a specific area of your home for business on a continuing basis."

If your home office is used for any non-business purpose during the year, or only sporadically in connection with your business, no deduction is allowed.

How To Claim This Deduction

To claim the home office deduction, you need to complete and attach a Form 8829, Expenses for Business Use of Your Home, to your federal income tax return. On that tax form, you'll prorate your allowable household costs by the percentage of your home that is used in connection with your business. You make this calculation by dividing the square footage of your office by the total square footage of your home.

Allowable costs include mortgage interest, real estate taxes, utilities, repairs and maintenance, and insurance. You'll also include the rent you pay, or depreciation based on the amount you paid for the home (reduced by the value of the land), plus improvements.

You'll then deduct those costs directly against net self-employment income on the Schedule C or as a miscellaneous itemized deduction on the Schedule A, if you're compensated as an employee.

Are you self-employed? If so, the home office deduction also reduces the self-employment taxes you pay.

More Information

More information about the home office deduction can be found at the IRS' website, where you can download Form 8829 along with instructions, as well as IRS Publication 587, Business Use of Your Home.

- Andrew D. Schwartz, CPA

Andrew D. Schwartz, CPA is the editor and a major contributor to Real Estate Pro Taxes, a website that provides income tax and financial planning information geared towards real estate professionals. Schwartz has provided financial planning advice in interviews with various media, including the Washington Post and Wall Street Journal. He is available for interviews.