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Ever worried that claiming a home office deduction could lead to an IRS audit? Tune in to this episode of the Ask Ralph Show with Ralph Estep Jr. as he tackles the question of whether taking a home office deduction might lead to an IRS audit. How do I prepare for an audit of my home office expenses? With Ralph Estep, Jr.
In this episode of the Ask Ralph show, host Ralph Estep Jr. addresses the common concern of whether claiming home office deductions could trigger an IRS audit. Ralph offers practical advice on how to legally and confidently claim these deductions without fear. He shares a listener's question about home office expenses, highlighting the importance of proper documentation and the pitfalls of incorrect deductions through compelling examples. Ralph also covers the IRS guidelines for qualifying a home office, allowable expenses, and red flags that might attract an audit. He underscores the necessity of honest and thorough record-keeping to avoid any issues with the IRS.
00:00 Episode Overview
00:39 Listener's Question
02:06 Bible Verse
02:47 The Importance of Proper Documentation
04:26 Common Mistakes in Home Office Deductions
07:12 Qualifying and Documenting Your Home Office
10:34 Action Steps for Home Office Deductions
11:21 Recap and Final Thoughts
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[00:00:00] Ralph Estep, Jr.: Have you ever wondered if your home office deduction might trigger an IRS audit? Imagine confidently claiming your home office expenses without fear of an audit. Well today's show, I'm going to tell you how to do that. So stay tuned to learn how to protect yourself and maximize your deductions legally. That's the key to the whole thing.
[00:00:24] Ralph Estep, Jr.: If you missed yesterday's episode on why you might consider collecting social security benefits early, be sure to catch up at askralph.com. It could truly be a game changer for your retirement planning.
[00:00:39] Ralph Estep, Jr.: Let's dive into a message that we got from Dana. She writes this.
[00:00:43] Ralph Estep, Jr.: "Dear Ralph, I've been working from home for the past two years, and I'm thinking about claiming a home office deduction on my taxes. But I'm really worried about getting audited. What expenses can I safely deduct and how can I document everything properly? I'd hate to make a mistake and end up in hot water with the IRS. It's just a small side business, but it does provide some extra income for our family. I want to claim the income, but I also want to deduct those expenses I can deduct so I can limit my tax liability. Any advice will be greatly appreciated."
[00:01:16] Ralph Estep, Jr.: Well Dana, thank you for this excellent question. It's one of the many of us who work from home grapple with, and I'm glad you're being proactive about it. Before we dive in, I want to remind you that this show is all about answering your questions. So keep them coming. You can email me at ralph@askralph.com or visit askralph.com and click on the microphone icon and then just tell me what's on your mind.
[00:01:41] Ralph Estep, Jr.: Welcome to the Ask Ralph show. I'm your host, Ralph Estep Jr., and I'm here to help you master your finances from a Christian perspective. So I want to thank you for joining me today. And don't forget to visit askralph.com and join our community. When you do, you get a free copy of my book, Mastering Your Finances. Now this book normally sells for $10 on Amazon, but it's my gift to you when you join our email list.
[00:02:06] Ralph Estep, Jr.: Let's start with a powerful Bible verse that speaks directly to our topic today. Let's use the book of Matthew 25:23. It says this. "His master replied, 'well done, good and faithful servant! You've been faithful with a few things; I will put you in charge of many things. Come and share your master's happiness!'" What a powerful and wonderful verse. This verse emphasizes the importance of being faithful and being responsible with the resources we have, which aligns with the theme of managing finances clearly today.
[00:02:47] Ralph Estep, Jr.: Now, let me tell you a story I think will drive home the importance of proper documentation for home office expenses. I once had a client. Let's call him Tom who came to me, he was in a panic. He had just received notice of an IRS audit, focusing specifically on his home office deduction. Tom had been claiming this deduction for years, but he'd always been a bit, I'd say casual about his record keeping. That's an understatement. When Tom first started his business, he was so excited about the prospect of saving money on taxes that he went a little overboard. In fact, he actually claimed 50% of his home as his office space. He deducted his entire internet and phone bill, and even tried to write off his weekly grocery shopping as what he told me, he called office supplies because he sometimes eats lunch at his desk.
[00:03:35] Ralph Estep, Jr.: Now you're probably thinking, "Ralph, that's crazy. Who would do that?" But you'd be surprised how often I see people make these kinds of mistakes, usually as a simple misunderstanding rather than any intent to defraud the IRS. Anyway, fast forward, the IRS came knocking. Tom was in a real bind. He couldn't provide accurate measurements of his office space. He had no system for tracking which phone calls or internet usage was for business versus personal. And don't even get me started on those grocery receipts. You know, those thermal things had just faded away.
[00:04:07] Ralph Estep, Jr.: What was the result? Tom not only had to pay back thousands and I mean, thousands in disallowed deductions, but he also faced hefty penalties and interest on top of that. It turned into a financial nightmare that could have been easily avoided with proper planning and documentation. Well, let me share some interesting examples of home office deductions the IRS has generally not allowed. These are just a few of some of the things I've seen in my 30 years of practice. Let's talk about swimming pools. Some taxpayers have tried to deduct the cost of installing and maintaining a swimming pool claiming it was for stress relief related to work. The IRS typically rejects this. I guess you could say those taxpayers were flushed with deductions. Moving right on.
[00:04:52] Ralph Estep, Jr.: Let's go to lawn care. While maintaining a home office space is deductible, people have even attempted to deduct their entire lawn care expenses, arguing that a well-maintained yard is necessary for a professional image. This is usually not accepted. I guess it doesn't make the cut. Okay. That's a bad one.
[00:05:11] Ralph Estep, Jr.: Let's move on. How about pets as security systems? There have been cases where individuals tried to deduct pet related expenses. Now they claim their dogs or cats served as security for their home office. The IRS generally doesn't buy this argument. Now maybe I could try that with my black Angus cows here on the farm. Has anyone actually heard of a guard cow? My jokes are not funny today, are they?
[00:05:35] Ralph Estep, Jr.: Well let's move on. Artwork and decor. While some office decor may be deductible, taxpayers have pushed the limits by trying to write off the expensive artwork or elaborate decorations that go well beyond what's considered ordinary and necessary for a home office. Actually, I had one client who constructed a water fountain in front of his home and wanted me to deduct it as a business expense because he claimed it was a professional backdrop for his zoom meetings. Uh, no.
[00:06:01] Ralph Estep, Jr.: The next thing. Family vacations. Some clients have attempted to deduct entire family vacations by claiming they were working during the trip for their mobile office. Listen, unless it's a legitimate business trip, this doesn't fly with the IRS.
[00:06:16] Ralph Estep, Jr.: Let's talk about clothing. People have tried to deduct their entire wardrobe as a business expense for their home office, arguing they need to look professional for video calls. Listen, the IRS only allows deductions for clothing that's not suitable for everyday wear. Now, this is what I've seen a lot with my realtor clients. But unless they have some sort of realtor uniform, it's not going to pass the test.
[00:06:39] Ralph Estep, Jr.: And here's one. Rent for the entire home as a deduction. While you can deduct a portion of your rent based on the size of your home office, some have tried to deduct the entire rent claiming their whole home was their office. This is almost always rejected. And these examples might seem crazy, but they highlight the importance of understanding IRS guidelines for home office deductions. It's always best. Let me say that again. It's always best to consult with a tax professional for specific advice on what you can and cannot deduct.
[00:07:12] Ralph Estep, Jr.: So Dana, how can you avoid Tom's fate and safety claim your home office deductions? Let me break it down for you. First, let's talk about what qualifies as a home office. The IRS generally has two basic requirements. Number 1. You must use a portion of your home regularly and exclusively for business. And number 2. It must be your principle place of business or a place where you meet clients or customers in the normal course of business. Now you might be asking, "Ralph what expenses can you deduct?" There are two methods to that.
[00:07:42] Ralph Estep, Jr.: There's one called the simplified method. You can deduct $5 per square foot of your office space up to a maximum of 300 square feet or basically $1500. You might also use what they call the regular method. This allows you to deduct a percentage of your home expenses based on the percentage of your home used for business. This includes your mortgage interest, your property taxes, utilities, insurance, repairs, appreciation, all those things, but you're taking a percentage of it based on the square footage. Here's where careful documentation comes in. What you've got to absolutely do. You've got to measure your office space accurately and calculate what percentage of your total home it represents. The next thing you need to do is keep detailed records of all home related expenses. For those things like utilities and other shared expenses, keep a log to track business versus personal use. Another tip is to take photos of your home office setup, and finally keep a calendar of business activities conducted in your home office.
[00:08:43] Ralph Estep, Jr.: Now you might be asking me, "Ralph, what are some red flags that might trigger an audit?" The things I talked about earlier certainly would, but let's talk about some others. One of the big ones is claiming a hundred percent business use of a vehicle. If you use your vehicle for anything other than business, it's not a hundred percent.
[00:09:00] Ralph Estep, Jr.: How about deducting meals and entertainment that aren't directly related to business? That's a good one. I hear that all the time. Husband and wife will own a business. They'll come into me, and they say, "Ralph, we went out for dinner this week. I'm writing it off through the business because guess what? We talked about business." I don't think that's going to fly. Another one is claiming a home office deduction when you also have a traditional office elsewhere. If you're provided an office by your employer, if you got an office elsewhere, you're not going to be able to take that personal home office deduction. Another big one. I see this almost all the time and that's deducting a hundred percent of your internet and phone bill. I've actually had clients argue with me and say, "well, if it wasn't for my business, I wouldn't have a phone and I wouldn't have internet." Yeah, I'm not buying that one either. And finally, claiming a very large percentage of your home as office space. I've had clients say to me, "well, you know, I do business in the basement Ralph, I store products there. I do it in the kitchen cause I meet with clients. I do." Yeah. That's not going to fly. Remember, it's got to be exclusive use for the business.
[00:09:57] Ralph Estep, Jr.: Remember in all of this, the key is to be honest, the key is to be accurate, and the key is to be thorough in your record keeping. Don't stretch the truth or inflate your deductions. It's not worth the risk. Let me share a quick personal experience. When I first started my accounting practice, I work from home. I was meticulous about measuring my office space. I tracked my expenses, and I kept everything separate. It took some extra time but when I was audited a few years later, I got that letter audit. I was able to confidently provide all the documentation the IRS requested. The result? My deductions were upheld, and the audit was closed without any changes. So here are some action steps for you to take right now if you've got a home office. Number 1. Designate a specific area of your home for your office and use it exclusively for business. When I say exclusively, I mean, exclusively. Number 2. Set up a system for tracking all home office related expenses. Number 3 is I talked about this earlier. Take photos and measurements of your home office space. And number 4. Consider consulting with a tax professional like me. And I'll talk to you later in the episode how you do that to ensure that you're claiming everything you're entitled to without overstepping those bounds. Remember this. A home office deduction can provide significant tax savings, but it needs to be done right. Don't let fear of an audit prevent you from claiming what you're legally entitled to do. Just be diligent, be honest, and thorough in your documentation.
[00:11:21] Ralph Estep, Jr.: Well, let's recap. We've covered what qualifies as a home office, what expenses you conduct, how to document everything properly, and what red flags to avoid. Remember, the key is regular and exclusive use, accurate record keeping, and honest reporting.
[00:11:38] Ralph Estep, Jr.: Thank you for tuning into today's tax talk Thursday. Now tomorrow we're going to be discussing what are the 4 basic types of student loans. It's a must listen to for anyone with college bound kids or considering further education on their own. And listen, if you'd like personalized help managing your finances including navigating tricky areas like home office deductions, I'm going to invite you right now to schedule an appointment with me. You can do that in askralphpodcast.com/store, and you can book your session right there. If you're ready, do it right now before you forget. So as I always say, stay financially savvy, and God bless you.
