Tuesday, February 4, 2003

Home office deduction worth the hassle

(Fourth in a series)

By Amy Higgins
The Cincinnati Enquirer

Don Westermeyer does most of his financial planning work in a spacious office attached to his Hamilton Township home. It's convenient for him and many of his clients. And it provides a nice - if confusing - income tax deduction for him.

"It doesn't come more complicated, but it's a help in the long run," Westermeyer said.

Saturday: Getting your records organized
Sunday: What's new for 2002
Monday: Often missed work-related deductions
Today: Does it make sense to deduct a home office?
Wednesday: Education related credits and deductions
Thursday: Reducing taxes without itemizing
Friday: Which filing status is best?
Saturday: IRS Free File and online tax chat on Cincinnati.Com

Tax chat: Visit Cincinnati.Com from 11 a.m.-noon Feb. 8, Feb. 22 and March 8 for our third annual series of Tax Chats. Questions will be answered live by Tom Cooney and Crystal Faulkner, partners in the accounting firm of Cooney, Faulkner and Stevens.
Questions: E-mail questions throughout the week to tax@enquirer.com. Answers to commonly asked questions will be printed in Saturday editions of the Enquirer through April 12.
Indeed, the IRS places stringent requirements on who is eligible for the deduction. The actual process for taking the deduction is complex, as well. In order to qualify for the deductions, home offices must:

• Be used solely for business purposes, not as a secondary television room or after-hours kids' play room.

• Be used to meet clients, patients or business associates.

• Be the taxpayer's principal place of business and used at the convenience of the employer, not a worker.

That final requirement might have been an obstacle to Westermeyer's taking the deduction because he also maintains an office at American Express Financial Advisors in Springdale. But the IRS provides an exception if the office is actually separate from the rest of the house, as is Westermeyer's.

So, like Westermeyer, if you do qualify to take a home office deduction, the place to start is to figure what your home's cost basis is, said Mark Luscombe, principal tax analyst at tax information publisher CCH Inc.

Then figure out, typically by square footage, what percentage of your home is dedicated to the home office. That percentage of your cost basis may be deducted in equal increments over 39 years. Along with that, you can deduct that percentage of some utilities and other housing costs.

Here's an admittedly simplistic example:

Say you bought your home for $200,000, and one-tenth of it is an eligible home office. Also say that you spent $2,400 a year in utilities and other housing costs.

One-thirty-ninth of the one-tenth of the home's cost basis ($20,000/39) plus one-tenth of the annual costs ($240) would give you a home office deduction of almost $753 - for a tax savings of $226 for someone in the 30 percent bracket.

But it's not exactly that simple. And the complications don't end there. That depreciation you take on the home office must be recaptured and taxed at 25 percent when you sell the home.

Using our same oversimplified example, if someone sold his home after six years, he would have depreciated $3,077 (six years x $20,000/39), which is then taxed at 25 percent. So he would owe $769 on the home's sale, while having saved $1,356 with the deductions over those six years.

The longer the home office is used and the higher the taxpayer's income, the more tax savings are seen, despite the complicated calculations. "There is an advantage to doing it," Luscombe said. "To me, the deduction is worth the hassle of figuring out the deduction."

E-mail ahiggins@enquirer.com

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