Home Office Deduction: What You Need To Know

The home office deduction is a tax deduction available to self-employed people or partners who use part of their home for their business. This includes renters and homeowners, and the home can be a house, apartment, condo, or similar property. To qualify for the deduction, you must use a portion of your home exclusively for conducting your business regularly, and your home must be your principal place of business. The IRS offers a simplified option for calculating the deduction, which has been available for tax years starting on or after January 1, 2013. This method uses a prescribed rate multiplied by the allowable square footage used in the home, with a maximum of 300 square feet. The standard method involves completing IRS Form 8829 to compute the actual amount of deductible home office expenses.

Exclusive and regular use

The exclusive-use rule does not mean that you are forbidden from making a personal phone call from the office or that you have to rush outside whenever a family member needs a moment of your time. According to some advisers, you meet the spirit of the exclusive-use test as long as personal activities invade the home office no more than they would be permitted to in an office building.

There is no specific definition of what constitutes regular use. If you use an otherwise empty room only occasionally and its use is incidental to your business, you would fail this test. If you work in the home office a few hours each day, you might pass. This test is applied to the facts and circumstances of each case the IRS challenges.

Principal place of business

To qualify for the home office tax deduction, your home office must be your principal place of business. This means that you must use your home office exclusively and regularly for administrative or management activities, and you must not have any other fixed location where you conduct these activities.

The exclusive-use rule means that you can only use your home office for business purposes. However, there are some exceptions to this rule. You do not need to meet the exclusive-use test if you use your home for the storage of inventory or product samples, or if you use your home as a daycare facility.

The regular-use rule means that you must use your home office for business on a continuous, ongoing, or recurring basis.

The principal place of business test considers the relative importance of the activities performed at each place where you conduct business, as well as the amount of time spent at each location.

If you meet the exclusive-use, regular-use, and principal place of business tests, you can deduct expenses for the business use of your home. These include direct expenses, such as painting or repairs made to the specific area used for business, and indirect expenses, such as insurance, utilities, and general repairs for your entire home.

To calculate your home office deduction, you can use either the simplified method or the actual expenses method. The simplified method allows you to deduct a standard rate per square foot of your home office, up to a maximum of 300 square feet. The actual expenses method requires you to calculate the percentage of your home used for business and deduct a portion of your total expenses based on this percentage.

Simplified option for calculating deduction

Simplified Option for Calculating Home Office Deduction

The simplified option for calculating the home office deduction is a method provided by the Internal Revenue Service (IRS) to make it easier for small business owners to determine the amount of expenses they can deduct for qualified business use of their homes. This option simplifies the calculation and record-keeping requirements of the allowable deduction. Here is what you need to know about the simplified option:

Highlights of the Simplified Option:

• Standard deduction: You can claim a standard deduction of $5 per square foot of your home used for business purposes, up to a maximum of 300 square feet. This means you can deduct up to $1,500 ($5 x 300 square feet) without having to provide detailed calculations.
• Itemized deductions: You can claim allowable home-related itemized deductions in full on Schedule A, such as mortgage interest and real estate taxes, without reducing these expenses by the amount allocated to the business use of your home.
• No depreciation deduction: When using the simplified option, you cannot claim a depreciation deduction for the portion of your home used for business. This also means that you won't have to recapture depreciation upon the sale of your home for the years you used the simplified option.

Limitations of the Simplified Option:

• Qualified business use: The simplified option can only be used for the qualified business use of one home. If you have multiple homes with qualified business use, you will need to use the standard method for the others.
• Actual expenses: You cannot deduct actual expenses related to the qualified business use of your home in the same year you use the simplified option. The simplified option provides a standard deduction in lieu of your actual expenses.
• Gross income limitation: The amount of the deduction computed using the simplified option cannot exceed your gross income derived from the qualified business use of your home, reduced by unrelated business deductions. Any excess amount cannot be carried over to subsequent years.

How to Choose and Apply the Simplified Option:

• You can choose to use either the simplified option or the standard method for any taxable year. However, once you have chosen a method for a particular year, you cannot change it for that year.
• To elect the simplified option, simply claim the amount of deductible expenses allowed under this method on your timely filed, original federal income tax return for the taxable year.
• The simplified option is available for taxable years beginning on or after January 1, 2013.

Remember, the simplified option does not change the criteria for who may claim a home office deduction. You must still meet the requirements for exclusive and regular use, principal place of business, or other qualified business use of your home.

Standard method for calculating deduction

The standard method for calculating the home office deduction is also called the detailed method, and it involves two steps.

First, you must calculate the percentage of your home that is used for business purposes. This can be done by dividing the area used for your home office by the total area of your home. Alternatively, if all the rooms in your home are roughly the same size, you can divide the number of rooms used for your business by the total number of rooms in your home.

Second, you must itemize your home office expenses, which are separate from your business expenses. Direct expenses are those that only relate to the part of your home that you run your business from, such as paint, flooring, and repairs. Indirect expenses relate to the cost of living in your home overall, such as rent, mortgage, property taxes, utilities, and depreciation.

Once you have the percentage of your home that is used for business and the total of your direct and indirect expenses, you multiply the two to get the amount of your deduction.

For example, if your home office takes up 150 square feet and your home is 1,200 square feet, your business percentage would be 12.5%. If you have $7,000 in indirect expenses and $500 in direct expenses, you would multiply $7,500 by 12.5% to get a deduction of $937.50.

The standard method is more complex than the simplified method, which allows you to multiply the square footage of your home office by a prescribed rate ($5 per square foot, up to 300 square feet). However, the standard method may result in a larger deduction, especially if your home office takes up more than 300 square feet.

Expenses that qualify for deduction

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

Simplified Method

The simplified method allows you to deduct a prescribed rate per square foot of your home office space, up to a maximum of 300 square feet. The prescribed rate is $5 per square foot, with a maximum deduction of $1,500 for a 300-square-foot space. This method does not require you to worry about classifying or allocating expenses.

Actual Expenses Method

The actual expenses method is more complicated but may result in a larger deduction. This method requires you to track all your home office expenses, including repairs and maintenance costs. You can deduct a portion of certain home-related expenses, such as:

• Mortgage interest
• Property taxes
• Homeowners' insurance
• Utilities
• Repairs and maintenance
• Security system expenses
• Maid service
• Garbage disposal
• Decorating expenses
• Depreciation

To determine the deductible amount, you need to calculate the percentage of your home devoted to business activities. This percentage will then be applied to the eligible expenses to determine the deductible portion.

It is important to note that only expenses directly related to your home office or expenses that benefit your entire house, including your home office, are deductible. Expenses that benefit only the personal portion of your home are not deductible.

Frequently asked questions