Home Office Improvements: Tax Write-Off?

Whether you can write off home office improvements depends on your employment status and the type of improvement. Self-employed people can deduct the costs of improving their home office space, but employees cannot. Repairs that restore a home office to its original state are tax-deductible, but renovations that increase the value of the home are not.

Repairs vs. Improvements

Repairs and improvements are treated differently when it comes to tax deductions. Repairs are tax-deductible in certain circumstances, while improvements generally need to be depreciated over several years.

Definition:

A repair is any modification that restores a home to its original state and/or value. Repairs are generally tax-deductible for home offices and rental properties. Examples of repairs include fixing a leaking faucet, mending a broken window pane, or replacing a few loose shingles on a roof.

On the other hand, an improvement is any modification that increases the value of your home, adapts it to new uses, or prolongs its life. Improvements typically cannot be deducted in the year they are made but may provide tax benefits when you sell your home. Examples of improvements include adding a new driveway, installing a new roof, renovating a kitchen, or adding a new septic system.

Tax Treatment:

The main difference in the tax treatment of repairs and improvements lies in the timing and amount of the deduction. Repairs, being necessary for the upkeep of a property, can usually be deducted in full within the tax year they are completed. This is because they are considered a current expense.

Improvements, on the other hand, are considered capital expenditures and must be capitalized and depreciated over several years. This means that you can deduct a portion of the improvement's cost each year, typically based on a depreciation schedule. The reasoning behind this is that improvements provide a long-term benefit, so it is more appropriate to spread the deduction over multiple years.

It is important to note that the distinction between repairs and improvements can sometimes be blurry, and the IRS has issued lengthy regulations to clarify this difference. When in doubt, it is best to consult a tax professional or advisor.

Self-employed people can deduct home office expenses

• A principal place of business, or
• A place to meet with customers or clients.

If you use a separate structure, such as a converted barn, pool house, or detached garage, you can claim deductions if you use the space regularly and exclusively for any business purpose.

The term "exclusive use" means that you use the office space only for business purposes for the entire year. Your home office qualifies as your principal place of business if most of your income-earning activities take place there. It can also be your principal place of business if you use it to conduct administrative or management functions, such as bookkeeping and processing invoices, and you don't conduct these functions at any other fixed location.

There are two methods for claiming this tax break: the actual expenses method and the simplified method. With the actual expenses method, you can deduct direct expenses, such as repairs made directly to your office space, in full. Indirect expenses, such as mortgage interest, insurance, and utilities, are deductible based on the percentage of your home used for business.

The simplified method allows you to deduct a prescribed rate per square foot of home office space, up to a maximum of $1,500. This method does not require you to keep track of actual expenses, but it may result in a smaller deduction compared to the actual expenses method.

Employees cannot deduct home office expenses

Since the 2018 tax reform, at-home expense deductions for employees have been reduced but remain for self-employed workers. Prior to the 2018 tax reform, employees could claim these expenses as an itemized deduction.

The Tax Cuts and Jobs Act (TCJA) suspended write-offs for miscellaneous deductions that were formerly subject to the 2%-of-AGI rule. So, under current federal-income-tax law, an employee’s home office expenses aren’t deductible.

The TCJA also eliminated other unreimbursed employment-related expenses, such as professional business license fees, work-related supplies, and travel expenses.

The home office deduction is a tax break for self-employed people who use part of their home for business activities. Small-business owners and freelancers who regularly and exclusively use part of their home for work and business-related activities may be able to write off rent, utilities, real estate taxes, repairs, maintenance and other related expenses.

The home office deduction can be taken on Schedule C of Form 1040 (annual tax return). You can claim the deduction whether you’re a homeowner or a renter, and you can use the deduction for any type of home where you reside: a single-family home, an apartment, a condo or a houseboat.

Convenience of the employer test

Employees may only take the home office deduction if they maintain the home office for the convenience of their employer. An employee's home office is deemed to be for an employer's convenience only if it is:

• A condition of employment
• Necessary for the employer's business to properly function
• Needed to allow the employee to properly perform their duties

The convenience of the employer test is not met if using a home office is for your convenience or because you can get more work done at home.

Basic home office requirements

For any home office to be deductible, you must:

• Use a part of your home regularly and exclusively for work
• Have your home office as your principal workplace or regularly perform administrative or management tasks there

You can't take the home office deduction unless you use part of your home exclusively for your business. In other words, you must use your home office only for your business. The more space you devote exclusively to your business, the more your home office deduction will be worth.

Additional requirements

Using a home office exclusively and regularly for business is not enough by itself to qualify for the home office deduction: You also must satisfy at least one of the following additional tests:

Home as principal place of business

The most common way to satisfy the additional home office deduction requirement is to show that you use your home as your principal place of business. If you do all or almost all of your work in your home office, your home is clearly your principal place of business and you'll have no trouble qualifying for the home office deduction.

If you work in more than one location, your home office still qualifies as your principal place of business if you perform your most important business activities—those activities that most directly generate your income—at home. Most employees probably can't qualify on this basis.

If you perform equally important business activities in several locations, your principal place of business is where you spend more than half of your time. Thus, if you spend more than half of your time in an office provided by your employer, you won't qualify.

You do administrative work at home

You can also qualify for the home office deduction if:

• You use the office to conduct administrative or management activities for your employer
• There is no other fixed location where you conduct substantial administrative or management activities

Administrative or management activities include, but are not limited to:

• Billing clients or patients
• Keeping books and records
• Setting up appointments

Depreciation

In the context of home office improvements, depreciation can be applied if you are self-employed and use a portion of your home exclusively and regularly for business purposes. This could include using it as your principal place of business or a place to meet with clients. If you meet these criteria, you can depreciate the cost of improvements made to your home office over 39 years. This involves deducting a percentage of the original cost of the renovations every year, which works out to a little over 2% in the first few years.

It's important to note that depreciation is different from a tax deduction. While tax deductions reduce your total taxable income, depreciation reduces the value of your assets over time due to wear and tear, deterioration, or obsolescence. In the context of home office improvements, you can't deduct the cost of the improvements directly, but you can depreciate them and claim the depreciation as a business expense.

Additionally, there are special considerations for leasehold improvements, which refer to improvements made by a tenant to a leased property. Leasehold improvements can include changes such as installing new floors, building walls, or adding fixtures. These improvements are typically capitalized and then depreciated over the shorter of the useful life of the improvements or the lease term.

Overall, depreciation can be a valuable tool for spreading out the cost of home office improvements over time, but it's important to understand the requirements and guidelines for claiming it.

Direct and Indirect Expenses

On the other hand, indirect expenses benefit both the home office and the rest of the house. You can only deduct a portion of this expense, which is calculated based on the percentage of your home that is used for business. For instance, if you pay $1000 to repair the roof of your home, this is an indirect expense because it benefits the entire house. If your home office makes up 15% of your home, you can deduct $150 (15% of $1000) of the cost.

Some common indirect expenses include:

• Casualty insurance premiums
• Homeowner association fees
• Security monitoring
• Depreciation for a residence that you own
• Rent for a rented residence
• Mortgage interest
• Insurance
• Utilities
• Repairs
• Real estate taxes

Frequently asked questions