Equine Accounting: Home, Sweet Home (Office Deduction)

If you use a portion of your home for business purposes, you may be able to take a home office deduction if you meet certain requirements. In order to claim a business deduction, you must use part of your home for one of the following two reasons: 1. Exclusively and regularly as either: your principal place of business, or as a place to meet or deal with clients in the normal course of your business. To meet the test for exclusive use, you must use use a specific area of your home only for your trade or business. And you must have no other fixed location where you conduct substantial administrative or management activities of your trade or business. For example, if you conduct part of your business from an office located in your barn, you could not also claim home office expenses for the same business activity. And you must use this space regularly, rather than incidentally or occasionally.
2. On a regular basis for certain storage use -- such as storing inventory or product samples -- as rental property, or as a home daycare facility.
The use of the office must be for “substantial managerial or administrative activities” such as billing customers, keeping books and records and scheduling appointments. The business activity associated with the home office need not be your main activity but the home office must be the principal place of business for your sideline activity. For example, an attorney working full time may judge at horse shows on weekends. If the home office is not used for purposes other than those associated with being a judge, the expenses associated with the home office should be deductible for tax purposes. Generally, the amount you can deduct depends on the percentage of your home that you used for business. Usage is commonly allocated based on the percentage of square footage allocated for business use but any other reasonable method would be acceptable.
Different rules apply to claiming the home office deduction if you are an employee. For example, the regular and exclusive business use must be for the convenience of your employer. If you own your home and qualify to deduct expenses for its business use, you can claim a deduction for depreciation. Depreciation is an allowance for the wear and tear on the part of your home used for business. You cannot depreciate the cost or value of the land.
HOWEVER (you knew there had to be a downside), if you sell your house, any depreciation taken on a home office after May 6, 1997 must be recaptured at the rate of 25 percent (for taxpayers in tax brackets over this amount). You cannot use the home sale exclusion to offset this tax. You cannot avoid the recapture by not reporting depreciation. Recapture applies to depreciation both claimed and claimable. If you want to avoid the depreciation recapture, you must choose to sidestep the deduction entirely by disqualifying the home office (by NOT using the space entirely for business). You will miss out on the depreciation expense but can still deduct related costs such as office maintenance.
For more information, see IRS Publication 587.