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January / February 2000

• Expanded rules for home office deductions went into effect in 1999. The Taxpayer Relief Act of 1997 amended the IRS Code to provide that the term "principal place of business" includes a place of business that is used by the taxpayer for the administrative or management activities of any trade or business if there is no other location where the taxpayer conducts substantial administrative or management activities for that trade or business. Congress made this amendment because there was overwhelming sentiment that the Supreme Court's decision in N.E. Soliman was unfair to taxpayers in our electronically sophisticated world, one in which many individuals are running their businesses from a home office.

• The home office must be used exclusively on a regular basis as a place of business. In the case of an employee, the use of a home office for management or administrative activities must be for the convenience of the taxpayer's employer.

• The fact that the taxpayer also conducts administrative, management activities, or payment processing activity at sites that are not fixed locations of the business, such as a car or hotel room, will not affect the taxpayer's ability to claim a home office deduction. In addition, a taxpayer's eligibility to claim a home office deduction will not be affected by the fact the taxpayer conducts substantial non-administrative or non-management business activities at a fixed location of the business outside the home.

• However, in the case of an employee, if an employee chose not to use suitable space made available by the employer the present-law "convenience of the employer" test might not be satisfied. No deduction could be claimed in such a case unless the taxpayer could establish that the home office was the principal place of business.

• Before a taxpayer takes a deduction for the home office, it's very important to consider whether he plans to sell his home though a realtor. The rules for exclusion of gain on sale of the principal residence require that the taxpayer use the home two out of the last five years as a principal residence. If a person uses a portion of his residence as a home office for more than three years out of the five year period ending on the date of sale, the exclusion of gain will not apply to the portion of the gain attributable to the business use of the home.

• If a person is going to lose a big tax benefit by taking home office deductions, it might be wiser to forego the deduction. If depreciation had been taken on the portion of the home used as a home office, some of the gain on the sale of the house may have to be recaptured as ordinary income.

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