Home Office Expenses: What's The Cost?

If you work from home, you may be able to claim tax deductions for expenses related to your home office. The home office deduction is a tax break for self-employed people who use part of their home for business activities. This includes small-business owners and freelancers who regularly and exclusively use part of their home for work. Employees who work from home are generally not eligible for this deduction.

The home office deduction allows taxpayers to deduct certain home expenses when they file their taxes. These expenses may include mortgage interest, insurance, utilities, repairs, maintenance, depreciation, and rent. However, it is important to note that there are specific requirements that must be met to claim these deductions, and there may be limitations on the deductible amount.

There are two methods for calculating the home office deduction: the simplified method and the actual expenses method. The simplified method offers a standard deduction of $5 per square foot of home used for business, up to a maximum of $1,500 for a 300-square-foot space. The actual expenses method involves measuring actual expenditures against overall residence expenses and deducting a portion of these expenses based on the percentage of the home used for business.

Home office tax deductions for small-business owners

Small-business owners can claim tax deductions for their home office expenses. To qualify, you must meet specific criteria and follow certain procedures. Here is a detailed guide to help you understand and navigate the process.

Eligibility Criteria

To be eligible for the home office tax deduction, you must meet one of the following criteria:

• Exclusive and Regular Use: You must regularly and exclusively use a portion of your home specifically for business purposes. This includes structures on your property, such as an unattached studio, barn, or garage. It does not include spaces used for hotels, motels, or similar businesses.
• Principal Place of Business: Your home office must be the primary location of your business or a place where you regularly meet with clients. Exceptions include daycare and storage facilities.

Calculating the Deduction

There are two methods to calculate your home office tax deduction: the simplified method and the regular method.

• Simplified Method: This method is based on a prescribed rate multiplied by the square footage of your home office, with a maximum of 300 square feet. For 2023, the rate is $5 per square foot, resulting in a maximum deduction of $1,500.
• Regular Method: This method is based on the percentage of your home devoted to business use. You can deduct direct expenses in full and indirect expenses based on the percentage of your home used for business. For example, if your home office occupies 15% of your home, you can deduct 15% of your rent, mortgage interest, utilities, and other allowable expenses.

Important Considerations

When claiming the home office tax deduction, keep the following in mind:

• Exclusive Use: Your home office must be used exclusively for business purposes. Personal activities in the designated space may violate the exclusive-use requirement and forfeit the deduction.
• Recordkeeping: Maintain accurate records of your business expenses, home office usage, and eligibility criteria. This will help you defend your deduction in case of an IRS audit.
• Depreciation: If you use the actual expenses method, you must depreciate the value of your home, which may be subject to capital gains tax when you sell your home. The simplified method does not include depreciation.
• State and Local Laws: Some states allow employees working from home to claim the home office tax deduction, while others do not. Check your state's laws to ensure compliance.

Calculating the value of your home office tax deduction

There are two methods to calculate the value of your home office tax deduction: the simplified method and the actual expenses method, also known as the regular method.

The Simplified Method

The simplified method calculates the value of your home office deduction by multiplying the square footage of your home office space by a prescribed rate. The rate is $5 per square foot for up to 300 square feet of space, with a maximum deduction of $1,500. This method simplifies the calculation and record-keeping requirements of the allowable deduction but does not change the criteria for who may claim a home office deduction.

The Actual Expenses Method

The actual expenses method, also known as the regular method, values your home office by measuring actual expenditures against your overall residence expenses. This method is more complex and requires determining the percentage of your home devoted to business use. Direct expenses, such as painting or repairs solely in the home office, can be deducted in full. Indirect expenses, such as mortgage interest, insurance, utilities, and real estate taxes, are deductible based on the percentage of your home used for business. This method may provide a larger deduction but requires more detailed record-keeping.

Important Considerations

When choosing between the simplified and actual expenses methods, consider which method will result in a larger deduction for your specific situation. Additionally, keep in mind that once you choose a method for a taxable year, you cannot change to the other method for that same year. It is also important to note that employees who work from home are generally not eligible for the home office tax deduction, although some states do allow this deduction for employees.

The simplified method for calculating home office tax deductions

• Determine eligibility: The simplified method can be used by self-employed individuals who use part of their home for business activities. This includes small business owners and freelancers. However, employees who work remotely for another company are not eligible for the home office deduction.
• Calculate the allowable square footage: Measure the square footage of the portion of your home that is used for qualified business purposes. This could be a separate room or a dedicated space within a room. The allowable square footage is the smaller of the portion of your home used for business or 300 square feet.
• Apply the prescribed rate: Multiply the allowable square footage by the prescribed rate of $5 per square foot. This will give you the amount you can deduct from your taxes. For example, if your home office is 150 square feet, your deduction would be $750 (150 x $5).
• Consider exceptions: If you are providing daycare services, the prescribed rate is adjusted. Multiply $5 by a fraction, where the numerator is the number of hours you provide daycare services during the taxable year, and the denominator is the total number of hours during the year.
• Determine the deduction limit: The deduction cannot exceed the gross income derived from the qualified business use of your home, reduced by any unrelated business expenses. Any amount that is not deductible due to this limit cannot be carried over to subsequent years.
• Choose your method: You can choose to use either the simplified method or the regular method for any taxable year. However, once you have chosen a method for a particular year, you cannot change it for that year.
• Itemize deductions: If you itemize deductions, you can still deduct home-related expenses such as mortgage interest and property taxes separately on Schedule A of Form 1040 or 1040-SR.
• Understand depreciation: With the simplified method, there is no depreciation deduction for the portion of your home used for business, and you will not have to recapture depreciation when you sell your home. If you use the regular method in subsequent years, you must calculate depreciation using the appropriate optional depreciation table.
• Review qualifications annually: Eligibility for the home office deduction is determined each year, so your situation may change. Remember to review the criteria and choose the appropriate method for each taxable year.

Direct and indirect expenses for home office tax deductions

There are two types of deductible home office expenses: direct and indirect expenses. Direct expenses are fully deductible, while indirect expenses are only partially deductible. Direct expenses are those that relate solely to your workspace and do not benefit any other part of your home. For example, if you paint a room that you use exclusively as a home office, the entire expense is deductible.

On the other hand, indirect expenses relate to and are incurred by the whole house, so only a portion of them can be deducted. This includes expenses such as rent, mortgage interest, insurance, utilities, repairs, and maintenance. To calculate the deductible amount for indirect expenses, you need to determine the percentage of your home's square footage that is dedicated to your business. Then, multiply that percentage by the total expense. For instance, if your home office occupies 15% of your home's total area and you paid $1,000 in rent, you can deduct $150 as a business expense.

The IRS allows two methods for calculating home office deductions: the simplified method and the actual expenses method. The simplified method involves multiplying the square footage of your home office by a prescribed rate of $5 per square foot, up to a maximum of $1,500 for a 300-square-foot space. The actual expenses method, on the other hand, involves measuring actual expenditures against overall residence expenses. This method requires calculating and tracking depreciation, which can be more complex.

Renting your home office to your company

If you're self-employed or operate your business as an S corporation or partnership, you may be eligible for home office deductions, which allow you to write off a portion of your household expenses such as utilities, insurance, repairs, mortgage interest, property taxes, and depreciation. Even if you don't qualify for these deductions, renting your home office to your company can still save you tax money. For example, instead of taking a salary increase, you could rent your home office to the company, saving you both payroll taxes.

It's important to note that if you're an employee of a C corporation, you can't deduct home office expenses, even if you work from home most of the time. However, a possible solution is to have the C corporation rent the home office from you, as the rent is deductible by the company as a business expense. Keep in mind that the rent will be taxable to you, but you won't owe payroll taxes on it. This strategy may be viable for owners of C corporations when there is a legitimate business purpose for the arrangement.

When determining how much to charge for renting your home office to your company, you can calculate it on a pro-rata basis per square foot of the business use of home property. You can include not only rent but also other domestic expenses such as utilities and maintenance. However, it's important to consult with a tax professional or accountant to ensure that you're following the correct procedures and not triggering any red flags for an audit.

Frequently asked questions