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Home Office Expenses – the Tax Do’s and Don’ts

If you operate a home office, either as a business owner or an employee, you are probably keen to claim as many office expenses as you’re legally entitled to. However, there are a number of important regulations that impact what you can claim, and even whether you will end up paying Capital Gains Tax when you sell your family home.

You may legitimately be entitled to claim:

  • Occupancy expenses – this could include rent, the interest on your mortage (but not the principal repayment), rates, land taxes, and home insurance premiums
  • Running expenses – things like phone rental, business calls, internet fees, depreciation of office furniture and equipment, and any additional heating, cooling, lighting and cleaning expenses

To claim your occupancy costs, you must pass the ‘interest deductibility test’. In essence, this means that you are required to have an area of your home set aside exclusively for your business activities, such as an office or workshop, it’s not readily suitable or adaptable for private/domestic purposes, and it is used exclusively or almost exclusively for carrying on your business. This means, for example, that having a foldaway desk in a guest bedroom would not qualify – even if you use the room predominantly for your work.

If you do your business elsewhere, such as a principal office at a commercial location, you cannot claim occupancy expenses even if you have a home work area set aside.

Typically your occupancy costs are claimed as a percentage of the total floor area of your home. So if your office, workshop, or studio is 10% of your overall home space, you would claim 10% of the rent/interest, rates, insurance, etc…

However, if you claim occupancy costs including interest deductions on your mortgage for 10% of your home, when it comes time to sell your house you will need to pay Capital Gains Tax on 10% of the capital gain – the normal capital gains exemption that applies to your family home does not extend to the share that was used for commercial purposes.

If the ATO decides to audit you, they can ask for:

  • details of the income-producing activities undertaken at your home that resulted in running expenses additional to your normal domestic/private running costs
  • details of the home office, study, and other facilities or assets that you provide and maintain specifically and/or exclusively for work-related activities
  • a letter from your employer if you are in fact earning an income as an employee who is engaged to perform some of  your work duties from home
  • a letter from your employer stating that your home is a ‘place of business’ if they do not provide an alternative place of business

They can also ask for substantiation, which means:

  • a list of all items included in your claim, and receipts, accounts, or other documentary evidence for each item
  • where claims are based on a ‘representative pattern’, an estimate based on diary entries over a month period along with relevant accounts used to work out the deduction

A fixed rate of 34 cents per hour (effective from 1st July 2010) from home office expenses may be used once a representative pattern has been established for heating, cooling, lighting and the decline in value of furniture instead of keeping details of actual costs.

There may also be several other relevant details to consider, for example if you earn personal services income (PSI), so you’re best to consult your accountant or speak to Top Class Accounting. You can also download the Home-based business publication from the ATO.