It seems that we have come full circle with the home office write-offs as an audit flag.  When I started my business out of my home in 1995, the IRS did not view this as a normal business deduction.  During the late 90's, Y2K, and as late as 2008, it was viewed as a common buisness deduction. 

Well like everything else, the recent turn of events with our economy, things have changed!  If you are planning to take advantage of a home office deduction on your taxes, keep this phrase in mind....."ordinary and necessary".  Just because you write off expenses on your tax return, know that the IRS will take the ordinary and necessary stance.

For instance if your home based business reports $1,000 in sales, but want to write-off $5,000 worth of home office expenses, there are a couple of things to keep in mind.  First, the expenses from operating your business out of your home, will not create a loss.  It will only zero out any profit you may have.  Second, this is where the "ordinary and necessary" will come into play.  The IRS may question why you had to incur $5,000 of home office expenses to produce $1,000 in sales. If IRS feels the expenses are not necessary, they will not only disallow the deduction, but you will be responsible for any late fines and penalties for the error.

The other things to keep in mind are a couple of test questions for the home office write-offs:

  • Exclusivity - no other activities are to be conducted in this area but business.  Yes, this means no personal activity! 
    •  This also means that you have no other fixed location to conduct your buisness, so if you have a professional office or store front, you will not be able to deduct your home office.
  • Regularity - the home office must be used on a regular basis.  While this does not mean business has to be conducted every day, seasonal or occassional use of the area will disqualify your deduction.
  • Recordkeeping - you must keep records of all deductible activity on your tax returns.  You must have originals or copies of bills, invoices, or statements.  Bank statements alone will not be sufficient.  To make this most important easy, The Profit Tracker can help you track your sales, expenses, and inventory in one simple place.