Business Income Limitation

With most of your ordinary business expenses, if you have more expenses than you have income, your business can show a net operating loss that may be deductible against any other regular income you have (such as interest, dividends, or income from another job or business). This may even be true if the loss is a "paper loss" resulting from depreciation. However, it is not true of the home office deduction.

Your home office deduction is limited by the amount of your net business income. If your net income is too low, you won't be able to deduct the entire amount of your home office deduction this year.

If you use the regular method, you can carryover the amount that you cannot use to subsequent tax years. If you use the simplified method, you simply lose the value of the deduction.

Also, if you used regular method to figure your deduction for business use of the home in a prior year and your deduction was limited, you cannot deduct the disallowed amount carried over from the prior year during a year you figure your deduction using the simplified method. Instead, you will continue to carry over the disallowed amount to the next year that you use actual expenses to figure your deduction.

The IRS provides a lengthy discussion in applying this income limit in IRS Publication 587, Business Use of Your Home (Including Use by Daycare Providers).

When using the regular method, you must start with your gross business income from all sources (sales, interest on bank accounts, etc.), less all of your business expenses that are not part of the home office deduction. This is your tentative profit as shown on line 29 of your Schedule C, and is the maximum amount you can claim as a home office deduction this year.

Then, subtract the portion of your home office deduction expenses that you could otherwise use as itemized deductions: home mortgage interest, real estate taxes, and casualty losses computed as if the home office was your personal residence. (If the answer is zero or a negative number, you may be better off not claiming the home office deduction, and instead claiming these amounts as regular itemized deductions. This is especially true if you think your tax bracket next year won't be higher than your bracket this year.)

Assuming the answer to the previous step was a positive number, subtract the portion of your home office deduction expenses that would not otherwise be deductible as itemized deductions: insurance, repairs and maintenance services, utilities, and rent if you don't own the home.

Finally, you may subtract the extra business portion of any casualty losses, depreciation on your home, and any carried-over home office expenses from previous years. If the end result is zero or a positive number, you can deduct all your home office expenses. If the end result is a negative number, you may carry over the nondeductible portion to be subtracted on next year's tax return.

Example Sylvia Mousse is employed as an outside salesperson, and she meets all the requirements for deducting expenses for a home office. Her computation of expenses for the business use of her home, using the regular method, is as follows: Gross income from business: $6,000 less: direct business expenses (business phone, car expenses) -2,000 Balance: 4,000 less: deductible mortgage interest and taxes -3,000 Home office deduction limitation 1,000 other expenses for business use of home -2,400 Balance (carried over to the next year) -1,400

© 2024 Wolters Kluwer. All Rights Reserved.