If you use part of your residence as a "home office" to perform work-related activities, you may be entitled to claim a home office deduction on your income-tax return. The deduction can be quite valuable under the right circumstances, but the rules regarding the deduction are strict. The IRS recently reminded taxpayers about the distinction between personal and business expenses and the requirements for the deduction.

What Expenses Are Deductible?

Mortgage interest, real estate taxes, insurance, utilities, and various other expenses related to buying or renting a personal residence and repairing and maintaining the home usually cannot be deducted as business expenses. Despite this general rule, a home office deduction may be available if you use a portion of your home for business purposes. But only the business portion of your expenses can qualify for the deduction, and certain limits apply.

Exclusive and Regular Use

You may be eligible for a deduction if you use a portion of your home as your principal place of business or as a place to meet or deal with clients, customers, or patients in the normal course of business. A deduction also may be available if your work space is located in a separate structure that is not attached to your home. In any of these situations, the space must be used exclusively and regularly for business purposes.

Example. Milt, an attorney, uses the den in his home to write legal briefs and perform other activities related to his law practice. His family also uses the den for watching TV and entertaining. Because the den is not used exclusively in Milt's profession, he cannot claim a business deduction for its use.

Note that the exclusive-use test does not apply to space used for the storage of inventory or product samples. And, if you are an employee rather than self-employed, you have to meet additional requirements for the deduction: Your use of the home office must be for your employer's convenience, and your employer cannot rent the space from you.

Calculating the Deduction

Assuming you meet the tests for claiming a deduction, the next step is to determine the deductible amount. Essentially, it will be based on the percentage of your home that is used for business.

Two methods are commonly used to calculate the business percentage. Under one method, the area of the home used for the business is simply divided by the home's total area.

Example. Paula, a freelance photographer, uses a 200-square-foot bedroom in her apartment as her office. If the apartment is 1,000 square feet, the business-use percentage would be 20%. Assuming Paula has met the requirements for a home office deduction, she can deduct 20% of her rent, electric bills, and renter's insurance premiums as a business expense.

The second approach divides the number of rooms used for business by the total number of rooms in the house, assuming all of them are about the same size. Thus, if a home has 10 rooms of equivalent size and one room is used as a home office, the business-use percentage would be 10%.

IRS Warning