Know what you can - and can't - write off as a home-office expense

Few veterinarians conduct their entire practice at home, although many have an office at home where they perform some business tasks.

That raises questions about tax deductions for home-office expenses. Who is entitled to them and under what conditions? Those questions are best answered now – well before the end of the veterinary practice's tax year.

At the extreme, there are stories about folks who attempted to furnish their entire homes in rare antiques and write them off as a business expense. Others think they are entitled to a pass on the cost of a new stove, billiard table or hot tub, charging those to the government in the form of a tax deduction.

While such deductions often are attempted, rarely are they accepted by an ever-vigilant Internal Revenue Service (IRS).

But legitimate write-offs for home-office expenses do exist. Here are some basic criteria:

A home-office, clinic or hospital deduction is available for the expenses of using one's home for business purposes – but only for that portion of the home used exclusively and on a regular basis as a home office or clinic.

The deduction is available where the home office is the principal place of business, or is a place used to treat patients or meet with owners.

Veterinarians who own an animal clinic or hospital but use a home office only for administrative or management activities may qualify for the home office/studio tax deduction.

Deduct what?

The amount of the home office/studio tax deduction depends on a surprising number of factors. A practitioner must understand each component of the home-office deduction and how much was spent for each. To illustrate, he or she must know:

• The amount of rent if the home is not owned.

• Mortgage interest and real estate taxes if the home is owned.

• Depreciation if owned.

• Cost of insurance, utilities and services, repairs and decorating, whether owned or rented.

• Casualty losses, whether owned or rented.

Large expenditures, those so-called "capital improvements" such as remodeling costs – or at least that portion of them that apply to the area used for veterinary purposes – are recovered through depreciation write-offs.

Telephone charges, including taxes, for basic local telephone service on the first line of a residence usually are considered personal and not tax-deductible. But charges for additional lines, long-distance calls, extra equipment and optional services (such as call waiting) may be deductible.

Naturally, only that portion of expenses that pertain to the home office may be deducted – not the full amount for the entire residence.

The total deduction, however, is limited by the practice's income. Unlike other deductions that might result in a loss, the home-office deduction, plus all other business expenses, cannot exceed the practice's income for the year.

When a home is only a home

It is not necessary to qualify for the home-office deduction in order to claim some expenses associated with a home or a home-based business.

Home mortgage and real-estate taxes, for instance, are allowed as an itemized deduction on Schedule A of Form 1040, even if you cannot claim a home-office deduction.

Office supplies, postage and the cost of bringing a second telephone line into the home for business use also are deductible. You also may be able to depreciate or write-off the cost of computers and office furniture purchased to use at home, even if denied a deduction for the cost of a home office.

Employees also count

Employees must meet the same standards as a practitioner to deduct home-office expenses, but with a caveat: Their use of a home office to do their job must be for the employer's convenience, not their own. Unfortunately, there are no hard-fast rules to determine that, but certain facts and circumstances do come into play:

Obviously, if an employer does not provide space for the employee at the workplace, a home-office deduction is in order. But maintaining a home office simply for convenience usually will not pass IRS scrutiny.

Selling the home office and the home

Under tax rules, someone selling a principal residence may ignore up to $250,000 ($500,000 for joint filers) of the gain, so long as the home was used for at least two of the five years preceding the sale. This applies even if part of the dwelling was a home office.

Unfortunately, the exclusion does not apply to a home office in a separate dwelling, such as a detached garage. Nor does it apply to depreciation deductions for periods after May 6, 1997. Whether or not it was claimed on the tax return, depreciation always must be recaptured – added to the equation as if it had been claimed. All too often, recaptured depreciation is subject to a 25 percent tax on the gain realized on the sale.

Counting your assets

Capital expenditures, including the practice's Web site, computers, software programs and office furniture usually are recovered via depreciation over a number of years.

But for an immediate write-off of the entire cost of some capital assets, Section 179 of the tax law permits up to $108,000 (in 2006, adjusted for inflation in 2007) of qualifying assets to be "expensed," or immediately deducted.

If the veterinary practice expects to show a profit, however, the first-year expensing of Section 179 can reduce that profit.

Without profits or in situations where larger future profits are anticipated, it might be advisable to spread out depreciation.

Business-use requirements

A veterinarian can deduct expenses attributable to the portion of a home used exclusively and regularly:

• As the individual's principal place of business.

• As a place of business for patients, owners, suppliers or others meeting or dealing with the veterinarian in the normal course of practice.

• In connection with the practice, but in a separate structure that is appurtenant to, but not attached to, the home.

If the individual is an employee, he or she must not only meet these exclusive and regular-use tests, they must also prove that the business use of the home benefits the employer.

Exclusive use means that the designated business area is off-limits for any personal use during the tax year.

Regular use means on a continuing basis, not just occasionally or incidentally.

Traveling from a home office

A veterinarian working out of his or her home as his or her principal place of business usually can deduct the cost of travel from there to any business destination, including another office, visiting a client or project location or a bank, post office, supplier, etc.

If a home is not the principal place of business, a veterinarian must follow the general rules for determining whether a car trip is sufficiently business-related to be tax-deductible.

Veterinarians who do qualify for the home-office deduction also qualify for special, more liberal rules for deducting automobile expenses.

Home-office deductions give many veterinarians incentive to work from home, where local licensing boards permit.

Although an IRS auditor may get involved at times, DVMs usually find it worthwhile to look into home-office deductions. The rules are clear, easy to meet and can mean significant savings.

Mark E. Battersby is a financial consultant in Ardmore, Pa.