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Room service: Expand home office deductions

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in Small Business Tax,Small Business Tax Deduction Strategies

Don’t assume that you have to go along with the crowd on your 2012 tax return.

Case in point: If you’re self-employed, you may qualify for a home office deduction if your home is your principal place of business or where you regularly meet or deal with customers, clients or patients in the normal course of business. The IRS bases the deduction on the percentage of business use of the home.

Strategy: Use the business percentage method providing the biggest tax deduction. In other words, you don’t have to rely on the traditional method based on square feet if an alternative method is “reasonable.”

One common method that will meet the IRS standards is business percentage based on the number of rooms if the room sizes are com­­parable.

Here’s the whole story: If you qualify for home office deductions, you can write off direct expenses plus a proportionate share of indirect expenses like mortgage interest, property taxes, utilities, security monitoring fees and insurance. Also, you can claim a depreciation deduction for the part of the home used as an office.

Typically, the percentage entered on Line 3, Form 8829, Expenses for Business Use of the Home, reflects the square feet of the home divided by the square feet of the portion used for business, as referenced in the IRS instructions for Form 8829. But the “rooms method” may increase your deduction.         

Example: Assume you run a business from a 3,500-square-foot home with eight main rooms (not counting bathrooms, mud room, garage and basement). The room used for business is 280 square feet. In 2012, you incurred $7,500 of direct expenses and $15,000 in indirect expenses, plus you’re entitled to a 2.56% annual depreciation allowance based on a 39-year depreciation period for the business-use percentage for the structure.

The business-use percentage based on square feet is only 8%, but the number-of-rooms method yields a 12.5% business-use percentage. Here’s the deduction comparison if the total basis of the structure is $500,000:  

Thus, your deduction for 2012 is $1,250 more using the rooms method.

Tip: Your home office deduction can’t exceed your gross income from the business minus business expenses (other than home office expenses). Any excess is carried over.

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