A home office is a space within an individual's personal residence that is used for business purposes. It may be a corner of a spare bedroom equipped with nothing more than a desk. Or, it could be one whole floor of a house filled with the latest in computer and communications devices. Whatever its size and composition, however, the home office is increasingly common in American business today. A majority of the estimated 40 million Americans who work from their homes are self-employed small business owners. In addition, many professionals maintain two offices, and a growing number are equipping their home computers with modems that allow them access to their office computer files. Many large corporations are also expanding experiments in "telecommuting," which enables employees to work from home, using modem-equipped computers, just as they would in the office.
Establishing a home office involves a number of important considerations. For example, individuals interested in working out of their homes must gather information on local zoning restrictions, find and set aside an appropriate work area, and gain the support of family and neighbors for the home office. Other considerations include whether the home office will offer sufficient privacy, will be convenient for customers and vendors, and will provide room for future expansion and growth. The expense involved in furnishing a home office and purchasing necessary computers, office supplies, and other equipment is another factor to consider.
The use of part of a home as a business office may enable an individual to qualify for significant tax deductions. The "home office deduction" allows individuals who meet certain criteria to deduct a portion of mortgage interest or rent, depreciation of the space used as an office, utility bills, home insurance costs, and cleaning, repairs, and security costs from their federal income taxes. Although the Internal Revenue Service (IRS) has set strict regulations about who qualifies for the deduction, about 1.6 million people claim the deduction each year. According to Gloria Gibbs Marullo in an article for Nation's Business, the savings can be considerable: a sole proprietor living in a $150,000 home stands to save about $2,500 in actual taxes annually.
The most important aspects of setting up a home office are the potential tax and legal implications. Home office operators may claim a deduction for those offices on IRS Form 8829 (Expenses for Business Use of Your Home), which is filed along with Schedule C (Profit or Loss From Your Business). There are restrictions, however, which are covered in IRS Publication 587 ( Business Use of Your Home ). Failing to abide by these restrictions may put a red flag on a home office user's federal income tax return, which could result in an audit.
In general, a home office deduction is allowed if the home office meets at least one of three criteria: 1) the home office is the principal place of business; 2) the home office is the place where the business owner meets with clients and customers as part of the normal business day; or 3) the place of business is a separate structure on the property, but is not attached to the house or residence. The deduction is figured on the size of the home office as a percentage of the total house or residence. For example, if the total house size is 2,400 square feet and the home office is 240 square feet, 10 percent of the total house is considered used for business. That would allow the business owner to deduct 10 percent of the household's costs for electricity, real estate taxes, mortgage interest, insurance, repairs, etc. as business expenses.
Be warned, however, that the home office deduction cannot be used by everyone who has a home office. A 1993 United States Supreme Court decision made the home office deduction more difficult to apply outside of these very carefully worded circumstances. In the case in question, a doctor worked in three different hospitals, but did not maintain an office in any of them. Therefore, he established a home office, which he claimed was necessary to keep up with his billing and patient records, and claimed a home office deduction. But the Supreme Court ruled that since the doctor spent most of his working hours visiting patients, the hospitals were his principal place of work, and his home office deduction was denied.
This ruling, which more narrowly defined the concept of "principal place of business" affected a large number of people, particularly professionals such as sales agents who see customers at the customers' places of business. Since the demonstration and sale of the merchandise occurs away from the home office, the IRS ruling says that those offices are not critical to conducting that business. As a general rule, if the income-producing activity takes place away from the office, a deduction is not allowed. On the other hand, a second job conducted exclusively from the home office may qualify for the deduction. The key is that the income must be generated from the home office.
A home office deduction is still possible, however, if the space is set aside exclusively to meet with clients or customers, even if it is not always the principal place of business. The IRS uses an example of a lawyer who works three days in an office and two days at home in an office set up so that clients can come to his home. The last test for an unchallenged home office deduction is that it can be a separate structure—such as a studio or garage apartment—that is essential for running the business. For example, a floral shop owner who runs a greenhouse on her property would qualify under this rule.
In July 1997, responding to the concerns of small business advocates, the U.S. Congress passed a tax bill that effectively overturned the 1993 Supreme Court ruling. The legislation redefined an individual's "principal place of business" to include a home office that meets the following two criteria: 1) it is used to conduct the management or administrative activities of a business; and 2) it is the only place in which the small business owner conducts those management or administrative activities. When this change became effective on January 1, 1999, it was expected to enable many business owners who perform services outside of their homes to claim the home office deduction.
Even after meeting the criteria to qualify for the home office deduction, a myriad of different IRS rules apply to exactly what expenses can be deducted. These rules cover depreciation of the home, depreciation of equipment, how to recover that depreciation if the home is sold, etc. One important thing to note is that the monthly residential telephone charge cannot be deducted, even if most of the calls pertain to the business. However, long distance business related calls can be deducted. Individuals are advised to consult an accountant to stay within the law on home office deductions.
Besides the IRS regulations, some municipal governments have zoning laws that restrict and/or license home offices. Originally designed to protect residential neighborhoods from becoming commercial zones, the zoning laws have sometimes been strictly interpreted to keep residents from conducting any sort of business from their home, even if it does not have a commercial impact on the rest of the neighborhood. Zoning laws and ordinances may affect such varied issues as parking for customers, access for deliveries, the number and types of employees permitted, and the use of signs or other forms of advertising. As a result, people wishing to set up home offices should check with their city's zoning office and licensing board for restrictions that may apply to the city, or even to their particular neighborhood.
If a home-based business is allowed at the site, the next step is to determine whether a home office is a workable option in the residence. For example, individuals interested in working from their homes must consider where the office should be located, how much it will cost to equip the area for business use, and what adjustments will need to be made in living arrangements. While a home office offers an entrepreneur a number of tax and life-style benefits, it can also pose problems relating to limited space, isolation, household distractions, and security concerns.
Providing that a home office is feasible, the next step is to choose a location for the office. This location may be a spare bedroom, a den or study, a basement, an attic, a garage, a kitchen table, or a corner of a living room. When choosing a location for the home office, entrepreneurs should take into consideration their own working needs, the needs of clients who may visit, and the life-style needs of other members of their family. Though it is important for the home office to be located out of the mainstream of household activities, it also should be located in a desirable spot that will offer a pleasant working environment. The location of a home office is very significant; "in fact, almost every problem people have in working from home … is either aggravated or alleviated by where they put their offices," Paul and Sarah Edwards noted in their book Working from Home. At a minimum, the location chosen must be large enough to contain a desk and chair, computer and phone equipment, storage and shelf space, and contemplation or meeting space.
After a location has been determined, the work space must be clearly defined in order to eliminate potential distractions and create a good working atmosphere. "A peaceful marriage of home and office depends on establishing effective boundaries," according to Paul and Sarah Edwards. If no extra room is available in the home, it is possible to use room dividers or office partitions to creatively define the office space. It is vital that the space be well-lit, as lighting is key contributor to productivity. In addition, if clients are expected to visit the home office, then ideally the office should be the only part of the home they see. Thus if clients will visit regularly, it might be helpful to have an outside entrance to the office space. Besides defining the work space, it is important for an individual working out of his or her home to establish specific working hours and stick to them. Home-based business owners should let family, friends, and neighbors know when they are available for socializing and when they will be working. Otherwise, family members may interrupt business activities, or friends and neighbors may impinge upon work time with visits or requests for favors or baby-sitting services.
After a home office space has been defined, that space needs to be outfitted with the necessary equipment to conduct business activities. In her book Organizing Your Home Office for Success, Lisa Kanarek recommended plotting the available office space on a grid in order to help select and organize appropriate furniture and equipment. It may also be helpful to think in terms of vertical space as well as horizontal. For example, it may be possible to install storage shelves above a desk, or to use office walls for bulletin boards, dry-erase boards, or planning calendars. The most important consideration in selecting office furniture, besides fit with the available space, is ergonomics. After all, an average person spends 75 percent of his or her day sitting at a desk. If that desk is the wrong height, or the chair is uncomfortable, the entrepreneur may experience back pain, fatigue, carpal tunnel syndrome, or a variety of other productivity-reducing problems. In addition, Kanarek noted that individuals shopping for home office furniture avoid the temptation simply to seek out bargains. Poorly designed or constructed furniture will only need to be replaced, which may make it more expensive than selecting high-quality materials in the first place.
Some of the most costly equipment commonly purchased for home offices includes computers, printers, and other technological devices. According to Mike Brennan in an article for the Detroit Free Press, the first step in buying computer equipment for a home office is to evaluate what tasks it will need to accomplish. For example, a business that depends upon professional presentations may require a computer system capable of handling complex desktop publishing programs. The next step is to decide whether to buy the best computer model available to meet these needs, or to spend less money for an older, yet servicable model. In general, experts recommend that entrepreneurs buy the best computer that they can afford. Renting or leasing computer equipment may be an attractive option for small business owners who anticipate that they will not be able to afford top-of-the-line equipment, or who want to keep up with the rapid changes in technology prevalent in today's market.
In addition to the computer itself, home office workers today usually need to invest in a modem to connect their business computer to the Internet, to communicate with customers, and to facilitate e-mail and fax capabilities. The majority of home offices also purchase one or more peripheral devices—such as a printer, scanner, copier, or fax machine—depending on their needs. Brennan noted that a multiple function machine encompassing several of these peripherals may be a good way for home offices to save space, although such machines generally entail a tradeoff in the quality of any one function. Finally, a home office must also invest in software to perform work on the computer. Many new computers come with a variety of useful software already installed. One good general option for small businesses is Microsoft Office, which includes word processing and spreadsheet programs, as well as a variety of other business applications.
When establishing the physical layout of the home office space, it is also important to provide for storage of office supplies and business records. Most home-based businesses require at least one filing cabinet, shelves for books or manuals, and space to store paper and other office supplies. Office superstores, mail-order office supply companies, and computer shopping are all convenient options for home business owners in restocking their office supplies. Home-based businesses also need to provide the means for customer contact. Experts recommend establishing a separate phone line for business contacts, and equipping it with a reliable answering machine or voice mail system to handle calls during non-business hours. A separate phone line, which can be answered in a professional manner, gives more credibility and control to the small business owner, and also acts to solidify boundaries between an individual's business and personal life. Finally, some entrepreneurs choose not to use their home address in business dealings, either because of the image it projects or to protect their privacy and security. Home-based business owners may want to consider obtaining a post office box, renting an address from an office suite service, or using a mail receiving service as alternatives to using a home address for business correspondence.
Finally, individuals investing in a home office often need to make significant changes in their insurance coverage to ensure that their business is protected. For example, fire and theft coverage must be expanded to include business equipment, and liability coverage needs to include customers, vendors, and delivery persons visiting the premises. Depending on the type of home-based business, additional coverage may be needed to protect against business interruption, product or workmanship liability, and business use of a vehicle.
Brennan, Mike. "Do Your Homework: Setting Up an Office in Your House Can Be a Disaster if You're Not Computer Literate." Detroit Free Press. November 24, 1997.
Edwards, Paul, and Sarah Edwards. Working from Home: Everything You Need to Know about Living and Working under the Same Roof. Los Angeles: Tarcher, 1990.
Eliason, Carol. The Business Plan for Home-Based Business. Washington, D.C.: U.S. Small Business Administration, 1991.
Kanarek, Lisa. Organizing Your Home Office for Success: Expert Strategies That Can Work for You. New York: Penguin, 1993.
Kelsey, Dick. "IDC: New Technology Makes Home-Office Life Easier." Newsbytes. September 5, 2000.
Marullo, Gloria Gibbs. "Redefining the Home-Office Deduction." Nation's Business. September 1997.