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Tax Deductions

Can I deduct home office expenses?

Answer: If you use part of your home to conduct your trade or business, you might be able to deduct certain related expenses. To qualify for the home office deduction, you must pass certain tests.

You must use part of your home regularly and exclusively for your trade or business. Exclusive use means that this space is not used for any nonbusiness purpose, such as watching television, during the tax year of the deduction. If the space is used for business only sporadically or occasionally, you may not meet the regular use test.

Also, your home office must be used as either (1) your principal place of business or (2) a place where you meet customers, clients, or patients in the normal course of business. You may also be able to take a deduction if you use part of your home to perform administrative or management duties and you have no other location to do this work. If you are an employee and work from home, the business use of your home must be for the convenience of your employer in order to take the deduction.

Certain expenses for a separate structure, such as a garage, may be deductible if the structure is used regularly and exclusively in connection with your business or trade. A separate structure that’s used in this way does not have to be your principal place of business, or a place where you meet customers, to qualify for the deduction.

If you qualify under these tests, you can deduct certain expenses related to the business use of your home, but your deduction is limited by the percentage used for business and the deduction limit. You can deduct both direct and indirect expenses that apply to the portion of your home that you use for business purposes. Direct expenses are costs expended solely on the part of your home that you use for business purposes, and these can be deducted in full (subject to the deduction limit). They include such expenses as painting, and installation of separate telephone jacks and wiring. Indirect expenses are costs that benefit your entire home, including the portion you use for business. Indirect expenses include mortgage interest, property taxes, insurance, and so on. You may deduct a percentage of these expenses. You may use a square footage calculation or any other reasonable method to compute the business portion of indirect expenses.

If you are self-employed and not a farmer, you must file IRS Form 8829 to take advantage of the home office deduction. IRS Publication 587, titled Business Use of Your Home, offers more information on taking this deduction.

 

Can I deduct premiums paid for long-term care insurance (LTCI)?

Answer: It depends on several factors. Your LTCI contract must be a qualified one, and the total of your medical expenses (including your LTCI deduction) must exceed 7.5 percent of your adjusted gross income (AGI). Qualified LTCI premiums are deductible as medical expenses (subject to the 7.5 percent of AGI floor) within certain limits, based on your age.

If you bought your policy before January 1, 1997, and it met the requirements of the state in which it was issued, it is automatically considered a qualified policy. LTCI contracts issued subsequently are only considered qualified for a tax deduction if they meet certain federal standards. In 2010, qualified LTCI premiums are deductible as medical expenses (subject to the 7.5 percent of AGI floor) within the following limits, based on your age at the end of the tax year

Age: Limit on Deduction:
40 or less $330 (up from $320 in 2009)
41-50 $620 (up from $600 in 2009)
51-60 $1,230 (up from $1,190 in 2009)
61-70 $3,290 (up from $3,180 in 2009)
71 and older $4,110 (up from $3,980 in 2009)

For more information, consult a tax professional.

 

I paid my mother’s real estate taxes last year. Can I deduct this on my tax return?

Answer: Probably not. A real estate tax can be deducted only by the owner of the property upon which the tax is imposed. Therefore, if the deed to the property lies in your mother’s name, you are not entitled to a deduction for the real estate taxes even if you are the one who actually paid them. Generally speaking, taxes are deductible in the year you pay them.

Sometimes real estate taxes are prepaid. If you are the property owner, you can generally deduct prepaid real estate taxes in the year of the prepayment if (1) you are a cash basis taxpayer and (2) you don’t live in a jurisdiction where the taxing authority considers prepayment a “deposit.” Jurisdictions vary regarding how they treat prepaid tax. Be aware that taxes placed in escrow generally aren’t deductible.

 

If I work at home occasionally, am I entitled to a home office deduction?

Answer: To qualify for an income tax deduction for home office expenses, the IRS requires that you meet two tests–the place of business test and the exclusive and regular use test.

To pass the place of business test, you must show that you use a portion of your home as:

  • The principal place for any trade or business you conduct, including administrative use. The IRS uses a two-part test to determine if a home office is a taxpayer’s principal place of business. The test takes into account the relative importance of business activities performed at each business location and the amount of time spent conducting those activities at each place of business.
  • A place where you meet clients or customers in the normal course of business.
  • In the case of a separate structure that is not attached to your dwelling unit, you must show that you use it in connection with your trade or business (i.e., it needn’t be your principal place of business).

The exclusive and regular use test requires that you use that portion of your home both exclusively for business and on a regular basis.

Depending on the nature of your work, your occasional home use is unlikely to qualify for a home office deduction since it is doubtful you would meet the first test (because occasional implies it isn’t your principal place of business). You are also unlikely to satisfy the second test (because occasional implies that the use of your home isn’t exclusive or regular).

Because the rules are complicated, it might be wise to review IRS Publication 587, titled Business Use of Your Home, or consult a tax professional.

 

We just bought our first home. What can we deduct from the settlement statement?

Answer: If you took out a mortgage to purchase your home, you probably paid settlement costs in addition to the contract price. These costs generally include points, attorney’s fees, recording fees, title search fees, appraisal fees, and other loan or document preparation and processing fees. The only settlement costs you can deduct are home mortgage interest and certain real estate taxes. You deduct them in the year you bought the home if you itemize your deductions. Certain settlement costs can be added to the basis of your home. Other settlement or closing costs, however, cannot be deducted or added to the basis.

If the loan was for the purchase of your primary residence, the points withheld from the loan proceeds will generally be deductible as up-front interest if you paid a down payment, escrow deposit, or earnest money equal to the charge for points. Generally, you can also deduct any points paid by the seller. Real estate taxes are usually divided so that you and the seller each pay taxes for the part of the property tax year that each owned the home. You can deduct the taxes you actually paid during the year. However, you cannot take a present deduction for taxes paid in escrow for a future tax bill.

Other closing costs that you paid are not deductible and must be added to the cost basis of your home. You can include in your basis the settlement fees and closing costs that you paid that are associated with buying your home. You cannot include in your basis the fees and costs associated with getting a mortgage loan.

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