April 7, 2000

Home office may bring deductions

By TOM KELLY
The Real Estate Advisor

Are you on the lookout for a new home with the potential for a home office? Did you make a move last year so that you could finally work out of your house?

I have a friend who recently did just that. Now, he is transforming an old, dark space into a sparkling home office -- a spring remodeling project that will be as base for a home publishing company. It also raised several tax and financing questions.

The big piece at tax time was the move itself. Because my friend moved at least 50 miles and the new home office was going to be his principal place of work, accountants say all his moving expenses will be tax deductible.

“The key to any move is the time and distance test,’’ said Rob Keasal, certified public accountant with the Seattle firm of Anderson Zurmuehlen & Co. “If the person is moving to take a new job, then the new house must be 50 miles away from the site of the old job.

“A simple way to calculate is distance from the old house to the old job, plus 50 miles. The deduction can be taken in the year of the move, yet you have to stay there 78 weeks for the deduction to be valid. If you stay less than that, you will have to amend that year’s deduction.’’

Keasal said if the move to the new house with the perfect home office did not include a “new” job, then deducting all of your moving expenses could be questioned. However, there are ways of supporting your case, especially if you are a sole proprietor, in the event Uncle Sam pulls you out on the red carpet.

“I had a client who moved from Graham (Pierce County) to Stanwood (Snohomish County) and his move enhanced his geographic sales territory,’’ Keasal said. “The moving expenses -- even though he hadn’t taken a totally new job -- should probably be deductible. The Internal Revenue Service will consider your specific facts and circumstances, but you will first have to meet the time and distance test.’’

Tax advisors say the actual costs of moving business equipment, files and records should be handled separately from domestic belongings. That’s because business expenses can help reduce self-employment taxes.

According to Steve Bailey of the accounting firm of Ernst & Young, any cash paid toward the remodel will be considered part of the home’s cost and acquisition indebtedness. That means consumers reshaping bedrooms, garages, dens or adding an extra room to accommodate a home-based business can be added to the entire cost basis of the home when you sell.

What many home sellers forget to factor at tax time are the fees remaining from a previous refinance. All of those fees can be deducted in the tax year you chose to refinance a second time.

For example, let's say you jumped at a 30-year, fixed-rate loan at 6 1/2 percent in February, 1998. In order to get that lower, you had to pay at least 5 discount points. If the loan amount were $80,000, one discount point would amount to $800, and five points would be $4,000. Points paid to buy, build or improve your principal residence can be deducted in the year they are paid, as long as they were not rolled into the loan amount.

However, because you refinanced to simply obtain a lower interest rate, nearly all of the $4,000 must be written off over the life of the loan.

That's because the IRS sees refinancing points as repayment of existing debt. Last year, however, an unexpected need to send mom into a nursing home necessitated another refinance to pull some cash out of the home. You decide on an adjustable-rate mortgage with a very low starting rate and pay no fees. Now that the existing loan is paid off, the remaining balance of the $4,000 from the previous loan is deductible in tax year 1999.

If you did refinance last year, double-check your numbers. You can only deduct interest on the amount of the loan at the time you refinance, plus $100,000. For example, let's say you purchased your home 20 years ago for $100,000 and took out a loan for $80,000. Since then, you have paid the loan down to $20,000.

The house is now worth $275,000 and your oldest child now needs college tuition. The house definitely has equity to tap, but your mortgage interest deduction would be limited to the first $120,000 ($20,000 old loan at the time of "refi", plus $100,000).

Previous columns:

• Many professional, personal memories Kicked up with the Kingdome dust, 03-31-2000
• What happens when mistakes are made, 03-24-2000
• Microsoft promises home loan revolution, 03-17-2000
• Economist for NAR dusts off his crystal ball, 03-10-2000
• How to let someone rescue your deal, 02-25-2000
• Options for stock-rich, cash-poor homebuyers, 02-18-2000
• What lies ahead for real estate?, 02-11-2000
• Selling that vacation property, 02-04-2000