Home office deduction - politically incorrect question.

Disclaimer: I have never done this, and I do not advocate this. I am simply curious.

US IRS rules say that one's home office must be a room devoted exclusively to the stated use in order to get the home office tax deduction. Key word: exclusively. My question...

How would they know?

Seriously, if you also did your Facebook from your office in the evening, how would they know? Also, how would this be any different than renting actual office space and doing Facebook on your breaks?

IANAL, especially a tax lawyer, but here's my take...

Think tax avoidance versus evasion. The IRS, from my understanding, is fine with tax avoidance. Taking legitimate deductions is fine. As long as you try in good faith to stay within the law, that's okay. If you take a deduction in good faith and it isn't legitimate, you may need to pay back taxes and late penalties, but probably won't pay fines. Tax evasion is deliberately breaking the tax laws, and the IRS doesn't respond well to that. Back taxes, late penalties, fines, and even prison are all possibilities.

If you're taking a home office tax deduction, that raises an audit flag. Not too many people can legitimately take it. If you conduct business that is typical of someone with a home office and are creating revenue and paying taxes consistent with someone having a home office, your likelihood of audit is lower. In summary, if you take the tax deduction, you'd better fit the profile of someone legitimately taking this deduction.

If you are audited and someone comes to your home to see if you really have a home office eligible for the tax deduction, they're going to see how it looks. For today, if that room is the only room with a computer and you've got a spouse and kids, the likelihood of the agent believing you're using the room just for work is nil. They'll know that the room is used for personal activities as well as business activities. That's borderline tax evasion. If however it looks like a room that otherwise has nothing functional to do with the home and could otherwise be a business office in some other physical location such as an office building, you're probably just fine.

Here's a bit of a subtlety for you. Your home office should not contain any personal business. It is not where you should be paying your personal bills or storing important personal papers. Those things should be done or stored elsewhere in your home. While you might not have a personal office in your home, you should be able to show that you keep those things and activities separate from and outside of your home office.

For instance, if you were to use your living room as a sometimes portrait studio and the remainder of the time as a living room, you can't take the tax deduction of that room being a home office. If however you have a room used exclusively as a portrait studio, that's eligible for the tax deduction.

In closing, how could they tell if you used your home office to do Facebook at night or during breaks? I don't think they care. What they care about is whether you need to use that room for personal activities or not. Even if you are single, if it's the only room with a computer and network connection, you're unlikely to get them to accept that room as a tax deductible home office. If on the other hand you have a broadband home network connection in the main part of your home and a business broadband connection to your home office, and your home office is otherwise a separate entity from the rest of your home, all other things being equal you could spend all night in your home office doing Facebook, PotN, and anything else not work related. It would be as if you went out to go to your office down on Main Street or 5th Avenue and spent the night playing on the 'Net.

Does that make sense?

Going along with what Graham said, my accountant told me something similar. He may be just a very conservative guy, but he basically told me that to be safe claiming a home business office, I need to show two things:

1. A space and equipment where business finance and record keeping is done.

2. A space and equipment where all the personal finances and recordkeeping is done.

Thanks guys, but... I think you both missed the question. It had nothing to do with the legalities, or the definitions, or even the ethics of doing so.

Phrased another way... Does anybody personally know anyone who has "been caught" and gotten in trouble? I don't mean simply having the deduction denied and subsequently owing back taxes and penalties... I know a couple people who have had that happen, though for them it was a simple "paperwork denial", so to speak. Nobody actually showed up at their home, or anything.

Even with my disclaimer about my question being simple curiosity I know that some will still question my motive for asking. They will be wrong, but there's nothing I can do about that. I am simply curious. Nothing more, nothing less.

Short answer... The won't know.... Till you are audited. At that point it is pretty hard to prove anything.

I don't personally know anyone who has had an issue with the home office deduction, but my CPA has told me a few stories about some of her clients in the past who were audited for this. While not very common, the IRS may come to your "office" and do quite an inspection and the problem at that point is the burden is now on you to justify everything. She said it wasn't pretty and in almost every case they found something to nail them on. It was never a case of completely tossing out the home office deduction and getting cited for tax fraud, but it almost always meant losing some of the deductions claimed and paying some additional interest and penalties on the deductions that were reversed.

Sure, you can easily rearrange items in your house or something, but once that audit door is opened you better have meticulous records and proof of everything you stated on your return. The bottom line is the chance of an audit is extremely small as it is, and in most cases nobody knows whether or not every moment you step into your "office" you're doing work or not. But the takeaway is even if this is the case, you better make sure you have the records to support your claim.

My accountant's advice: "By all means, take the deduction if you qualify since you're entitled to it. Just don't be stupid."

RDKirk wrote in post #11717468
Going along with what Graham said, my accountant told me something similar. He may be just a very conservative guy, but he basically told me that to be safe claiming a home business office, I need to show two things:

1. A space and equipment where business finance and record keeping is done.

2. A space and equipment where all the personal finances and recordkeeping is done.

You also need to show a profit within a reasonable period of time.

My father always included something for them to throw out just to make them happy.

PhotosGuy wrote in post #11724474
My father always included something for them to throw out just to make them happy.

This applies when I send plans into a city for plan check, also. Not that I ever intentionally screw things up, but I know that if they can find something on which to comment, they feel happy and that they've done their job. If plans are too good, I run the risk that what they come up with will cause more trouble than it's worth. Sounds illogical, I know.

PhotosGuy wrote in post #11724474
My father always included something for them to throw out just to make them happy.

Hah! That's a good idea. It's true, they don't want to go through all that work and not find anything at all, so if there's at least a little something for them to get they feel they haven't wasted their time at least.