As regular readers know, I have a home-based business, this blog.  This last year I had a significant amount of income from it, and I try to reduce my taxable income as much as possible by finding legitimate deductions.  One of the deductions I looked very closely into this year was the home office deduction.  The way this deduction works is that you take all the expenses of your home, such as mortgage interest, real estate taxes, repairs, utilities, carpet cleaning etc and multiply them by a fraction.  The numerator of the fraction is the square footage of the home office, and the denominator is the square footage of the entire home.  For any utilities, furniture, or other stuff specifically used in the office, you get 100% of the cost as a deduction.  You also get to factor in some depreciation on the home (although this may be recaptured when you sell the home.)

How Much Is It Worth?

All those expenses added up to over $20K (half of which was mortgage interest) in my case.  Even when you multiply that amount by my relatively small fraction (2.54%), it still adds up to about $500, plus $300 in depreciation.  So that would mean I wouldn’t have to pay taxes on about $800 of my blog income.  Multiply that by 28% (federal marginal rate), plus 5% (state marginal rate) plus 2.9% (self-employment tax) and it’s like putting $287 in my pocket.  So why did I choose not to claim that deduction?

The Three Rules

In order to qualify for this deduction, you must pass three tests:

1) Principal place of your business.  In the case of this blog, I pass this test.  I certainly don’t have any other place where I conduct any significant percentage of this business.

2) Regularly used.  Given that this blog gets updated at least 3 times a week, I certainly pass this test.

3) Exclusive use.  This means that the square footage I’m claiming for a home office isn’t used for anything else.  Uh oh.  This one is a problem.  We have an office/library in the house.  It contains books (only some of which are related to my business), files (only some of which are related to my business), a desk and computer (used also for personal reasons by my wife and kids), and even the occasional forgotten toy.  I considered putting my official “home office” in two other areas of my home: a small nook in the basement that is used for almost nothing and the biggest room in the house- a large area in the basement currently strewn with toys.   But both of these spaces also failed the exclusive use test since they were used for non-business stuff during 2012.

Why I’m Not Taking The Deduction

I decided not to take the deduction this year for three reasons.  First, the home office deduction, for obvious reasons, is a big audit red flag.  It would take me far longer to prepare for and go through an audit than to make the $287 that this deduction saves me.

Second, I don’t actually qualify for it.  Sure, I could fake it to the IRS.  If they ask for a picture of the office I could take a few books out, make sure no toys are on the ground, take the picture, send it to the IRS auditor, and put all the stuff back.  Or if heaven forbid they decided to drive out to see the office I could clean it up before they showed up.  It wouldn’t be that hard.  I’m sure hundreds of thousands of taxpayers across the country are doing just that.  However, my perspective on taxes is that I’m willing to pay every dollar I legally owe, but I’m not leaving a tip.  I legally owe this tax, so I’m going to pay it. If my perspective on taxes were to pay as little as I could get away with, I can think of a lot of other ways to reduce my tax burden by far more than $287.

Last, it’s a bit of a pain in the butt to round up all your costs (and keep records on them in case of an audit.)  If you’re not getting a reasonably sized deduction, it just isn’t worth the hassle, especially when you factor in the audit risk.

Will I Take It Next Year?

As I finished up my 2012 taxes recently, I got to thinking that maybe we should make some changes in how we use the rooms in our house so we can qualify for this deduction next year.  Better yet, even increase the square footage of the home office area.  But the truth is the family gets far more than $267 worth of enjoyment out of being able to use our library/office throughout the year and if I even suggested they couldn’t use it I’d have a rebellion on my hands.  Now the big room downstairs that is currently strewn with random toys…that might be a different question.  That could be worth up to $1000 if I kept the kids out and started calling it my office.  Or even the little nook.  If I threw the mattress down in the big toy room when folks came to stay, then I could easily make the nook an exclusively used space.   Of course, then I’d have to go down in the basement regularly, and as my 3 year old will tell you, “It’s SCARY down there!”

Do you have a home business?  Are you claiming the home office deduction?  If not, why not?