The second hurdle is much higher than the first, but there are four ways to get around it.

The first way is if your home office is your principal place of business, meaning you do most of the work that earns your keep there. This is no problem for people like freelance writers and accountants.

Your home office also qualifies as your principal place of business (meaning it's deductible) if you use it for administrative and management activities — provided that you don't use some other fixed location to do these chores. This rule saves the day for to independent salespeople, construction contractors, plumbers, veterinarians, computer consultants and the like, who make their dough out in the field but do their paperwork at home.

The third exemption applies if you use the office to meet with clients. Even if you do most of your work elsewhere, as long as you regularly use your home office for meetings, it's deductible.

If you haven't qualified yet, there's still hope. If your office is in a building that is separate from your home, it qualifies. That means setting up your home office in a detached garage or outbuilding could get you a big tax break. Remember, in all of these scenerios, you must use your home office exclusively for business, and you must do so regularly.

What's It Worth?
Let's assume you pass all the tests. Now you want to add up your writeoffs. For sole proprietors, this is done on Form 8829 (Expenses for Business Use of Your Home). The rules go like this.

Deduct 100% of expenses that are directly related to the home-office space — for example, painting, cleaning and the premium for a home-office rider on your homeowner's insurance policy. Ditto for your office telephone line and utilities, if you have separate hookups.

You are also allowed to deduct a percentage of indirect expenses that relate to your entire residence. These include mortgage interest, property taxes, association fees, rent if you don't own your home, depreciation if you do (over 39 years), utilities, security monitoring, garbage pickup, general maintenance and repairs, insurance and so forth.

Knowing what you can deduct is the easy part, but figuring out how much of your indirect expenses you can write off is harder. Form 8829 leads you to believe you must use square footage, and most people do. Count only living space in figuring the percentage (not your garage, unfinished basement or covered patio). Also, if you have a bathroom adjoining your office that's never used otherwise, treat the square footage as part of your office.

Despite what the form says, you can also use any other "reasonable method" to compute the business use for indirect expenses. The easiest method is to count the number of rooms in your house and divide. If you have 10 rooms, you can deduct 10% of your indirect expenses. But this assumes your rooms are generally the same size. So if your 10x10 office is one of five rooms in your 3,000-square-foot house, deducting 20% for office use obviously won't fly if you get audited. By the way, the office doesn't have to be a separate room, just a defined space that you use for business.

One limitation on home-office deductions is that they can't put your business in the red. But that doesn't mean the deductions are wasted. Any amount that puts you below the break-even point gets carried over to the following year. And the limitation doesn't apply to mortgage interest and property taxes, which are generally fully deductible no matter how much money your business loses.

Employee Discounts
Sorry, but employees don't fare especially well under the Internal Revenue Service's home-office rules. You have to meet all of the above requirements, and you have to clear one additional hurdle. Your work-at-home arrangement must be for the convenience of your employer. That means telecommuters who work at home for the joy of it don't qualify. But if you spend so much time at home that your boss gives away your office, then you meet the convenience-of-the-employer test and qualify for the deduction.

Don't start counting your money just yet, though. Since you're not self-employed, your home-office deductions are counted as miscellaneous itemized deductions on Schedule A, rather than on Schedule C, where self-employed people calculate their profits and losses. (Mortgage interest and property taxes go on Schedule A, just as they always have.) The bad news is that you can write off your miscellaneous itemized deductions only to the extent that they exceed 2% of your adjusted gross income. So unless you have other miscellaneous itemized deductions (union dues, investment expenses, fees for tax preparation and the like) you will probably end up with a big zero where you thought you were getting a major writoff.

A final note on home-office deductions. To defend yourself in case of an audit, take pictures of your office (with the TV safely out of the frame) to back up your claim that the space is used only for business. Stash the photos in your permanent tax file.

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