The issue of whether or not a taxpayer can deduct expenses related to a home-based business is one the IRS pursues vigorously. It is important to understand when – and when not – it is appropriate to claim a portion of residential expenses as “business expenses.”
First, the activity must be a bona-fide business. There are numerous factors that the IRS will look at to determine if, in fact, the activity meets the definition of a business and not an “activity not entered into for profit.” Section 183 of the Internal Revenue Code specifically deals with these “hobby” losses.
Second, any area in the home that is claimed as used for business must meet strict requirements – such as, it must be used SOLELY for this business activity (no social, sleeping or other non-business activities can take place in this area), it must be an area separate and apart from the rest of the property (a separate room – it cannot be a portion of a large room), and the list goes on.
The IRS recently issued a Revenue Ruling advising taxpayers against taking deductions relating to a home based business that is not genuine – and warns of stiff penalties for not following its guidance. I have included the text to that ruling below for your reading.