Home Office Tax Exemption: What's Covered?

The home office tax deduction is a tax break for self-employed people who use part of their home for business activities. This includes freelancers, independent contractors, gig workers, and small business owners. To qualify, the space must be used regularly, exclusively, and primarily for business purposes. Employees who work remotely for an employer are not eligible for this tax break.

There are two methods for calculating the home office deduction: the simplified method and the actual expenses method. The simplified method allows for a deduction of $5 per square foot for up to 300 square feet, with a maximum deduction of $1,500. The actual expenses method involves calculating the percentage of the home dedicated to office space and multiplying this by the home's expenses, such as mortgage interest, insurance, utilities, repairs, and maintenance.

Who qualifies for the home office tax exemption?

To qualify for the home office tax exemption, you must meet the following criteria:

• You must be self-employed, a freelancer, a sole proprietor, or a partner in a business partnership. W-2 employees who work remotely for an employer are not eligible for this deduction.
• You must use a portion of your home exclusively and regularly for business purposes. This means that the space cannot be used for any personal purposes and must be used frequently throughout the year.
• Your home office must be your principal place of business. This means that it is where you conduct administrative or management activities, such as billing customers, keeping records, and setting up appointments. If you have another fixed location where you conduct a substantial amount of these activities, you may not qualify.
• The types of properties that qualify include houses, apartments, condominiums, mobile homes, boats, and similar structures. It can also include unattached structures on your property, such as a garage, studio, barn, or greenhouse.
• If you are claiming the deduction for a separate structure on your property, it must be used exclusively and regularly for business purposes.
• You must meet specific requirements set by the IRS, and the deductible amount of these expenses may be limited.

What is 'exclusive use'?

To qualify for the home office tax deduction, you must meet the exclusive use test. This means that you must use a specific area of your home only for trade or business purposes. The area used for business can be a room or any other separately identifiable space. The space does not need to be marked off by a permanent partition. However, you do not meet the requirements of the exclusive use test if you use the area for both business and personal purposes.

There are two exceptions to the exclusive use test:

• You use part of your home for the storage of inventory or product samples.
• You use part of your home as a daycare facility.

What is 'regular use'?

To qualify for the home office tax deduction, the space used for the office must be used regularly for business. This means using the space for business on a continuous, ongoing, or recurring basis.

There is no specific definition of what constitutes regular use, but it is clear that incidental or occasional use will not pass the test. If you work in the home office a few hours each day, you are more likely to pass the test. This test is applied to the facts and circumstances of each case.

If you are an employee of another company but also have your own part-time business based in your home, you can pass the home office test even if you spend much more time at the office where you work as an employee.

What is a 'principal place of business'?

A principal place of business is the primary location of a company. It is typically where the company's books are kept and where the leadership team is based. It is also known as the corporation's "nerve center" and is where the corporation's officers direct, control, and coordinate its activities.

Determining a company's principal place of business is important for tax purposes, as it affects the tax deductions that can be claimed. For example, if a company operates three retail stores and the owner also works out of their home, they may be able to deduct costs to maintain their home if it is established as the principal place of business. This is because the IRS allows certain deductions if a home is used to conduct business and specific tests are met.

The key to determining the principal place of business is where most of the administrative or management activities are performed. If there is no other fixed location where substantial administrative or management activities are conducted, then a home office can be deducted.

It is important to note that, according to the Supreme Court, a corporation can only have one principal place of business.

How do you calculate the home office tax deduction?

To calculate the home office tax deduction, you must first determine whether you are eligible for the deduction. To be eligible, you must be self-employed or a partner in a partnership, and you must use a portion of your home exclusively and regularly for conducting your business.

If you are eligible, you can choose between the simplified method and the actual expenses method to calculate your deduction.

Simplified Method

The simplified method uses a prescribed rate multiplied by the allowable square footage of your home office. The prescribed rate is $5 per square foot, with a maximum of 300 square feet. This method does not require you to deduct actual expenses, and you cannot deduct depreciation or home-related itemized deductions.

Actual Expenses Method

The actual expenses method values your home office by measuring actual expenditures against your overall residence expenses. First, calculate the percentage of your home used for your business by dividing the square footage of your home office by the total square footage of your home. Then, list all the expenses that pertain to your entire home, such as mortgage interest, real estate taxes, insurance, utilities, and depreciation for the year. Expenses incurred solely for the benefit of the office space are then listed separately. Finally, multiply the indirect expenses (expenses pertaining to your entire home) by the percentage derived earlier, and add this to the total of the direct expenses (expenses incurred solely for the benefit of the office space).

It is important to note that your total deductible expenses cannot exceed the income derived from the business for which the deductions have been taken. Additionally, if you are ever audited by the IRS, you will need to provide detailed records of all the business expenses you plan to deduct.

Frequently asked questions