Calculating the Home Office Deduction

In Michael H. Visin, TC Memo 2003-246, the Tax Court held that the taxpayers deduction for the business use of their home was limited to Schedule C net income calculated before the home office deduction. The court also disallowed the expensing of equipment purchases, because the taxpayers failed to elect Sec. 179 treatment.

Home Office Deduction

The taxpayers 1997 and 1998 returns reported Schedule C business losses of $9,299 and $8,644, respectively. Each return included a home office deduction, consisting entirely of rent paid, of $10,305 in 1997 and $10,643 in 1998. Under Sec. 280A(c)(5), the deduction for the business use of a home is limited to the amount by which the gross income generated from the business activity conducted in the home exceeds the deductions for expenses attributable to such activity not allocable to the business use of the home. Thus, the business use of a home cannot generate a net loss; the taxpayer may carry over the disallowed deductions to succeeding tax years. The court disallowed for 1997 and 1998 the portion of the home office deduction that resulted in a net loss.

Sec. 179 Expense Election

In addition, the court held that the taxpayers could not include $3,450 for computer equipment and software purchases in cost of goods sold on their 1998 return. Under Sec. 179 and Regs. Sec. 1.179-5(a), taxpayers need to make a Sec. 179 election on the first return (whether or not filed timely) for the tax year to which the election applies or on a timely filed amended return (including extensions) for such tax year. Because the taxpayers failed to elect to expense the equipment and software under Sec. 179 by filing Form 4562, Depreciation and Amortization, the Tax Court disallowed the expense.

Conclusion

Visin serves as a reminder that self-employed taxpayers should carefully file their returns. The tax laws are complicated; clients should consult with their tax adviser to avoid unexpected tax liabilities.

Vicky Chan, Gray, Gray & Gray, LLP, Westwood, MA