Tax 2-7 Analyze a situation to calculate the allowable home-office deduction.

Question 1

Home-office deduction

An individual uses the attic space of his home to store inventory. Occasionally, such space also is used for personal purposes. The expenses for the storage space are [deductible/non deductible] even though the attic is not used exclusively for business.

(2-7, pg 77)

Answer 1

Deductible

Question 2

Home-office deduction

Question 14 of 30

Which one of the following is not a requirement for claiming a home office deduction when inventory or product samples are being stored?

a. the trade or business must be the wholesale selling of products or services
b. the storage space must be used on a regular basis
c. the home must be the only fixed location of the trade or business
d. the inventory must be kept for use in a trade or business

(LO 2-7, pg 77)

Answer 2

a. the trade or business must be the wholesale selling of products or services

The trade or business must be the wholesale or retail selling of products, not services.

Question 3

Home-office deduction

Question 15 of 30

a. The home office expense deduction is limited to
b. gross income from the trade or business.
c. net income from the trade or business.
d. taxable income of the taxpayer.

(LO 2-7, pg 80)

Answer 3

c. net income from the trade or business.

The home office expense deduction is limited to the “tentative” net income from the trade or business—the net income prior to taking the home office expense deduction.

Question 4

Home-office deduction

Example: Calculating the Deduction for Indirect Expenses

Assume that John Hill uses a part of his home for business purposes. During the year, he had the following expenses:

Rent (home is not owned by John) $ 12,000
Insurance premiums 2,000
Utilities 1,500
Total indirect expenses $ 15,500

John uses 250 square feet out of 1,000 total square feet solely for business purposes.

The allowable deduction for the indirect expenses is:

(2-7, pg 80)

Answer 4

Step 1:

250 Sq Feet of Business Use
/ 1,000 Total Sq Feet
= 25% Business Use Percentage

  $12,000 Rent
\+ $2,000	Insurance Premiums
\+ $1,500	Utilities 
= $15,500 Total Indirect Expenses
* 25% Business Use Percentage
= $3,875	Allowable Deduction

Question 5

Home-office deduction

Question 24 of 30

Which one of the following is correct regarding the simplified safe harbor method of computing the home-office expense deduction?

a. Up to 500 square feet of home office may be taken into account under this method.
b. A rate of $10 per square foot of home-office space is used in the safe harbor computation.
c. None of the deduction is treated as depreciation.

(LO 2-7, pg 83)

Answer 5

c. None of the deduction is treated as depreciation.

Under the safe harbor method, none of the $5 per square foot of office space is treated as depreciation.

Question 6

Home-office deduction

Question 27 of 30

Which one of the following is not a permissible method for determining the business part of a residence for purposes of the home-office expense deduction?

a. square footage of the office area compared to the total square footage of the home
b. number of rooms in the house used for business compared to total rooms in the house
c. relative use method of allocation

(LO 2-7, pg 78)

Answer 6

c. relative use method of allocation

Both the relative square footage of the home office area and the relative number of rooms may be used in determining the business part of a home. There is no recognized method known as the “relative use method of allocation.”

Question 7

Home-office deduction

A taxpayer using his home for business purposes may deduct some expenses, including depreciation on the home, repairs, maintenance, utilities, insurance, real estate taxes, and mortgage interest for the portion of the home used for business purposes.

What requirements must be met by a self-employed individual in order to claim a home office expense deduction?

2-7

Answer 7

The home office must be used exclusively on a regular basis as a principal place of business or as a place for meeting with patients, clients, or customers in the normal course of business.

Also, if the office is used by the taxpayer to conduct administrative or management activities of the taxpayer’s trade or business, and

there is no other fixed location of the trade or business where the taxpayer conducts substantial administrative or management activities of the trade or business,

The regular and exclusive use test must still be met.

Question 8

Home-office deduction

Frank Johnson operates a sole proprietorship from his home. His gross income from the current tax year totals $12,000. Business expenses not associated with his home office total $10,500. Expenses associated with the home office total $2,750. Frank does not have a mortgage on his home, and did not pay any property tax during the current year. How much of the home office expense may Frank deduct for the current year? How is the remainder treated?

2-7

Answer 8

Under the safe harbor method, the taxpayer simply multiplies the allowable square footage by the prescribed rate. The allowable square footage is the portion of the home used in a qualified business use of the home, up to 300 square feet. The prescribed rate is $5. Thus, the maximum annual deduction is $1,500.

Frank may deduct $1,500 in home office expenses for the current year. The home office deductions for expenses other than home mortgage interest and property taxes allocated to the home office cannot create, nor add to, a loss. The remaining $1,250 may be carried forward.

This safe harbor method is an alternative to the calculation and allocation of actual expenses.

Question 9

Practice Test 2

Home-office deduction

19. Frank Johnson operates a sole proprietorship from his apartment. His gross income for the current tax year is $24,000. Business expenses not associated with his home office total $22,000. Expenses associated with the home office total $2,750.

How much of the home office expense, if any, may Frank deduct for the current year?

$0

$275

$2,000

$2,750

(LO 2–7)

Answer 9

$2,000

The home office expense deduction is limited to the “earned” income from the business. In other words, the home office expense deduction, in general, can neither create nor add to a loss. The only expenses that may create or add to a loss are the allocated amounts of home mortgage interest and property taxes. In this situation, the $24,000 of gross income is reduced by the $22,000 of business expenses not associated with the home office, to leave $2,000 of “earned” income. Thus, of the $2,750 of home office expenses, only $2,000 would be deductible in the current year. Note that the remaining $750 of home office expenses would be subject to a carryforward.