Excessive Home Office Tax Deductions are an IRS Red Flag

June 27, 2007— -- If you're getting started working from home, resist the temptation to claim all sorts of wacky home office tax deductions. Excessive claims for home office renovation and decorating are one of the fastest ways to an IRS audit. Apparently the first generation of telecommuters ruined it for the rest of us by installing pools and gourmet kitchens and such and claiming those were business necessities!

To claim expenses and avoid and audit when you use your home for business purposes, you must meet all the requirements outlined by the IRS.

Regular and Exclusive Use

If you use your office exclusively and regularly, you may qualify for business deductions on your taxes. To meet the requirements for regular use, the area specified in your home should be used on a regular basis, not for occasional business. Under the exclusive use test, you may use your office strictly for business use, not personal.

There are exceptions to the exclusive test. If a space in your home is used for storing inventory or product, you do not have to meet the exclusive use test. Also, if part of your home is used for a daycare facility, the exclusive use test does not apply. (Storage rooms and daycare facilities may have to meet other IRS requirements.)

Principal Place of Business

You must be able to prove that your home office is your principal place of business. You cannot have any other fixed location to conduct business if you want to deduct your home office expenses. The IRS also considers how much time you spend in the home office and the importance of the business activities you perform there.

If your office is a separate structure from your home it does not have to be your principal place of business, but it still has to be used regularly and exclusively for business. In this case, you can deduct expenses for the separate structure.

Percentage of the Home

You can either figure out what percentage your home office makes up of your home's total square footage. (Do this by dividing the area of your home office by the total area of your home.) Or if all the rooms in your home are about the same size, you can also divide the number of rooms used for business by the total number of rooms in the house.

Income versus Expenses

Bottom line: you DO NOT want to be audited. Ever.

Because our country's tax code is so complicated, you will probably have to hire professional accountants and maybe attorneys to help you. And guess what? Even if you prove you were in the right, the IRS doesn't reimburse you for the cost of defending yourself. So make sure you qualify for deductions and avoid math mistakes –another common trigger for IRS audits.

Miranda Twyman contributed to this report.