There is a common misconception, or some might even go to the extent of folklore, when it comes to deductions of a home office.  The folklore is that the home office deduction will automatically send up a "red flag" for an IRS audit.  Fortunately, this is false!  If you have legitimate home office expenses, you are legitimately entitled to the deductions.  In fact, the amount of audits is extremely low to what people assume.  The amount of Federal Income Tax Returns that are selected for audit each year account for less than two percent filed.  Usually, returns that are least likely for audit are those that the majority of the income was constrained to withholding from salaries and wages, and where the taxpayer does not itemize deductions on their Schedule A.  So, there is no need to be afraid of deducting the home office.

Why should you pursue the home office deduction?  For several reasons:  The portion of your home that is used for business is depreciable, and in being so is represented on your Schedule C.  The rest of the house is not depreciable.  The business portion of real estate taxes and home mortgage interest that are deductable on a Schedule A can now be moved to the Schedule C.  On a Schedule A, your Federal Income Tax (FIT) and State Income Tax (SIT) are reduced.  While, on a Schedule C, your FIT, SIT, and SE tax (self-employment tax) are reduced adding another 13.3% of reductions.  Along with these savings, any business use portion of otherwise non-deductible expenses such as utilities, repairs, homeowner's association dues, basic cable, etc., are converted to deductible business expenses, all on your Schedule C.  In doing so you are able to add your SE tax to your FIT and SIT reductions already achieved.

There are several things that need to be done in order to qualify for the home office deduction.  Exclusivity is key.  Meaning, the rooms used for business can ONLY be used for business and absolutely no personal use under any circumstances.  Along with that, the rooms for business use must be used on a regular basis.  The business use percentage must be: Your principle place of business, or a place where you meet or deal with patients, clients, or customers in the normal course of your trade or business, or a separate structure (detached from your home) used in connection with your trade or business. 

A home office deduction for a non-itemizer means instead of filing a Schedule A, the taxpayer will take the standard deduction.  You will do this if the standard deduction is larger than the itemized deduction existing, which is a benefit to you.  However, you can still deduct the business use portion of the home office expenses on your Schedule C.  On the other hand, a home office deduction for an itemizer means filing a Schedule A with your FIT.  In this case, the standard deduction is lower than your itemized deductions available.  In doing so, the taxpayer legitimately shifts the deductible business use portion of real estate taxes and home mortgage interest from their Schedule A to their Schedule C.  Therefore, the business portion of otherwise deductible, personal expenses, are now considered deductible business expenses resulting in 13.3% SE tax savings.

Of course there are many things to consider when taking home office deductions.  A good first step is to prepare a loan amortization schedule for your home mortgage.  This process can be very tedious so I will go through an abridged, quick version.  To begin with, a completed annual loan amortization schedule for your home should be available, which means you will most likely have to prepare one yourself.  This should include: each year of your loan, the payment, interest, principal, balance, and the totals of the categories.  After determining the total of these categories, the portion of home mortgage interest can then be reduced by FIT and SIT, and whatever portion of the house that is business use can reduce the additional SE tax.  Along with this, the amount of your home used for business use can be deducted from your real estate taxes and added on to your Schedule C as a business expense.  Resulting in an additional tax savings every year from SE taxes.  As well as the previous savings, the taxpayer may deduct the amount of the business use portion of the house from: their depreciation (net of recapture), their homeowner's insurance, and their utilities and repairs.  Every penny adds up.  So get the calculator out and get started on your home office dream, legitimately.