With the rise of technology, we are able to email, file share, video conference and more without ever having to step foot in a traditional office setting. Between technological advancements and greater self-employment opportunities in the digital space and beyond, the ability to work from home is at an all-time high.
If you are one of the many setting up shop at home, you may be eligible for considerable tax savings through a home office deduction.
What’s in this article
What is the home office deduction?
Simply put, you can deduct the cost of any workspace that you regularly and exclusively use for business, regardless of whether you own or rent it. The deduction can be used for any type of home, whether that be a single-family home, houseboat, condo, apartment or other. It can be used for separate freestanding structures such as studios, garages, workshops or barn space. As long as the space meets the requirements, you can set yourself up to save on your business taxes.
While it may sound fairly straightforward, the home office deduction is one of the more complex deductions currently offered today due to the qualifications.
The 2017 Tax Cuts and Jobs Act (TCJA) temporarily suspended miscellaneous itemized deductions claimed on Schedule A. While the tax reform did not directly impact the home office deduction, among the suspended items were unreimbursed employee expenses. Therefore, employees working from home for somebody else can no longer claim the home office deduction. However, you may qualify for the deduction if you operate a business from your home or are otherwise self-employed and regularly use part of your home for business.
How do I qualify for the home office deduction?
The Internal Revenue Service (IRS) holds strict requirements to qualify for the home office deduction. According to the IRS, home office expenses are deductible when a dedicated area of your home is used “regularly and exclusively as your principal place of business.”
Regular and Exclusive Use
The designated work space must be regularly used only for business. Incidental or occasional use is not permitted. Furthermore, the space cannot be used for personal and business use. While the room does not have to be structurally partitioned off, it has to be used exclusively for business. For example, the space does not qualify if your home office doubles as a guest bedroom.
There are two noteworthy exceptions to the exclusivity test: daycare services and storage. For example, if you provide daycare services to children, elderly, or handicapped individuals in a part of your house, you can still claim the deductions. You will need a license, certification or approval as a daycare center under state law. Additionally, you are exempt from the exclusivity rule if you utilize home space for the storage of inventory or product samples for your trade or business.
Principal Place of Business
Your specified home office space does not have to be the main location where you meet your clients or customers. However, it must be your principal place of business. More specifically, this means that you use the space exclusively and regularly for administrative or management activities. These activities include:
- Billing customers, clients or patients,
- Keeping books and records,
- Ordering supplies,
- Setting up appointments, and
- Forwarding orders or writing reports.
Again, the space qualifies as your principal place of business if you: 1) utilize the space exclusively and regularly for administrative or management activities for your business, and 2) do not have another fixed location where you conduct substantial administrative or management activities.
While the IRS specifically lists the two aforementioned qualifications as the basic requirements for a home office deduction, other qualifications do exist. You may be eligible to deduct expenses if you use part of your home:
- Exclusively and regularly as a place where you meet or deal with patients, clients or customers in the normal course of your trade or business;
- In the case of a separate structure which is not attached to your home, in connection with your trade or business;
- On a regular basis for certain storage use;
- For rental use; or
- As a daycare facility.
Certain restrictions and parameters exist, and some deductible amounts are limited. Follow the guidelines on IRS Publication 587 for further clarification.
What expenses can I deduct?
The home office deduction allows you to claim a deduction on more than the space itself. In fact, if you elect to use the regular method to calculate your deduction, you can claim other expenses as well. These include the business percentage of mortgage interest, home depreciation, property taxes, utilities, homeowner’s insurance, security systems and home maintenance.
For example, if your home office space occupies 20% of your total home space, then 20% of your annual electricity bill becomes deductible. More detailed information on how to determine your business percentage is available in the following section.
Note that some of these deductions, such as mortgage interest and home depreciation, only apply to those taxpayers who own their home office space.
How do I calculate my home office deduction?
There are two methods of claiming home office deductions: the simplified square foot calculation or the actual expense deduction.
Here is what you need to know about each:
The Simplified Method
As of 2013, taxpayers are able to calculate their deduction using the simplified method. This means you can simply multiply the square footage of your home office space by $5 and the total is your deduction amount. However, you can only claim a maximum 300 square feet, which adds up to a $1,500 deduction at most.
Other important points regarding the simplified calculation are:
- The regularity and exclusivity requirements are still applicable.
- Other normal business expenses not related to the home business, such as advertising, supplies and wages are still fully deductible. This is in the same way these expenses are deductible to non-home-based businesses.
- The amount of the deduction cannot exceed the net income of the business. This means the deduction cannot generate a business loss for tax purposes.
- You do not include depreciation or other home-related itemized deductions.
If you are operating out of a smaller home office space, under 300 square feet, the simplified calculation may be optimal.
The Regular Method and Form 8829
The regular method of calculating home office deduction is notably more difficult and requires precise record-keeping. This method determines the value of the space by measuring actual expenditures against your overall residence expenses. Through this method you can deduct mortgage interest, property taxes, maintenance and repairs, insurance, utilities and other expenses.
When employing this method, you can fully deduct direct expenses – such as painting or repairs – solely in the home office. For indirect expenses like the mortgage interest, utilities, real estate taxes or general home repairs, you must come to the deduction amount using a business percentage. For example, if the home office makes up 15% of your entire home, then you may deduct 15% of your annual property taxes.
To determine the business percentage of your home:
- Calculate the square footage of your home office.
- Determine the square footage of your home.
- Divide the area of your office by the area of your house.
- Multiply the decimal by 100 to obtain your business percentage.
In order to calculate your total home office deduction and list your actual expenses, use IRS Form 8829, “Expenses for Business Use of Your Home.”
Which is the better home office deduction method for me?
At the end of the day, the better method is entirely up to you. Some would advise you to calculate your deductions each way to accurately discern the greater deduction. However, if you do not have the means or desire to do that, we have a list of factors to consider:
- Size of your home office space. Given the maximum square footage parameters of the simplified method, if your space is 300 square feet or less, the simplified option is most likely best. However, if your office space is quite large, the regular method – which has no size limit – may be the better choice for you.
- Mortgage and Rental Rates. If the cost of home ownership or rental is particularly high, the regular method may yield a larger deduction. Also note that renters are not qualified for certain itemized deductions like mortgage interest.
- Home Depreciation. The simplified method does not include depreciation. However, you are able to claim real estate taxes and mortgage interest on Schedule A. On the other hand, if your home has depreciated, the regular method may be your better option.
- Record Keeping. The regular method requires accurate records of each expense listed on your Form 8829. Therefore, if you are not a fan of, or just not the most skilled at, detailed record-keeping then the simplified version is the way to go.
- Documentation and Form Filing. As the name indicates, the simplified method is simple. It requires six lines within a designated section in your Schedule C. The regular method necessitates a 43-line Form 8829 as well as a Schedule C when filing your tax return.
Anything else I should know regarding home office deductions?
On top of determining the optimal method of calculating your home office deduction, there are additional points of interest to keep in mind.
- If you plan on utilizing the regular method to calculate your deduction, make sure you are keeping extremely detailed records of any business expenses that may qualify. These include receipts for equipment, utility bills, repair invoices, etc. In the event of an audit you will be well prepared.
- There is widespread belief that claiming a home office deduction raises red flags for the IRS, since most people actually do not qualify. However, don’t let that stop you from taking advantage of a useful tax savings opportunity. In actuality, audits are quite rare.
- Homeowners claiming the deduction using the regular method may cancel out their ability to avoid capital gains tax when it comes time to sell their residence.
- Under the new rules, many telecommuting employees lost their ability to claim the home office deduction. If you are one of them or know someone who is, talk to your employer about establishing an accountable plan to offset the loss of the deduction. An accountable plan, outlined in IRS Publication 463, is a method for reimbursing employees’ out-of-pocket business expenses.
How can we help?
We at Squar Milner have worked tirelessly since 1938 to establish and maintain a reputation as an accounting firm comprised of trusted and experienced tax professionals. Our team is well-equipped to help you determine your eligibility for home office deductions, as well as ensure you are getting maximizing your tax savings on your business tax returns. Contact us for more details and answers to your questions.
Disclaimer: This material has been prepared for informational purposes only, and is not intended to substitute for obtaining accounting, tax, or financial advice from a professional tax planner or financial planner. All information is provided “as is,” with no guarantee of completeness, accuracy, timeliness or of the results obtained from the use of this information.