Working at home can create quite a tax shelter, at least until it comes time to sell your home and its office. First, if your home office qualifies for a tax deduction, you must calculate the amounts you are entitled to deduct on IRS Form 8829, "Expenses for Business Use of Your Home".

You file the form with your income tax return.

To determine how much you can deduct, measure the number of square feet used for your home business and divide that by the total square feet of living space in your home. The result is the percentage of your home you use for your business. It determines how much of your rent, depreciation, insurance, utilities and other related expenses you can deduct.

Nolo.com, the Berkeley, CA-based legal self-help publisher, says, if you are a renter, simply multiply the percentage by your annual rental payment, renters insurance and utilities to determine how much of each expense to deduct.

Likewise, if you own your home you use the percentage to figure your deductions. However, you must figure the deductions based only on the structure, not the land portion of the value. Your assessor can tell you how much your home is worth and the value of the land.

Take the deduction against the value of the home by depreciating the value over 27.5 years, if the business started during the years 1987 to 1993. Since 1994, the home value is depreciated over 39 years. If your business began before 1987, you use what's called "straight-line" depreciation, based on the estimated useful life of the property.

In any event, the amount of your home office deduction cannot be greater than the profit generated by your home-based business.

On Form 8829 you must separate all of your home-business expenses into two categories, "direct" and "indirect" expenses. Your home office area is a direct expense. Other costs, utility bills, insurance, etc., are indirect expenses.

You get a full tax deduction for anything spent exclusively for your home office, including equipment, equipment insurance, decorating, modifying, furnishings, maid service and the like.

"People forget. All the office expenses, pencils, pens, your office equipment, entertainment for business purposes. Travel to and from your home on work-related trips. The car mileage, legitimate business travel. Just keep records," said Bruce Hahn, president of the non-profit American Homeowners Foundation in Arlington, VA.

For the tax savings on indirect expenses, you apply the percentage of your home used for your business to household utilities, repairs, taxes, homeowner's insurance and the like.

Basic telephone service to your home is not deductible. Business-related long distance charges or a second phone line dedicated to your business are.

Unfortunately, the home office deduction isn't all roses.

Nolo.com says for home sales after May 6, 1997, you owe a "recapture tax" on the depreciation deductions previously taken on the business portion of your home. That means you pay back some of the tax savings and you cannot use the $250,000 per person home-sale profit exclusion to offset the recapture gain.

In other words, if you took a total of $15,000 in home office depreciation deductions over the past ten years, you will be taxed on $15,000 when you sell your home -- profitably or not.

That's a loophole closed by the Taxpayer Relief Act of 1997. Until then you could avoid paying the recapture tax if you stopped working from home long enough before you sold it. The law doesn't apply to renters, because they don't own their homes.

"When you sell your home you have to 'recapture' or give back a portion of the money, but the idea is that you'll be in a lower income tax bracket then," said Hahn

Part 1: