If you’re self-employed and work from home, you may be able to take the home office deduction. The home office deduction allows you to take a tax deduction based on the amount of your home you use for your business.
How much is the home office tax deduction?
There are two ways of calculating the home office deduction. The simplified option gives you a flat amount based on the square footage of your home office. In the regular method, you calculate your actual expenses.
The simplified option allows you to deduct up to $5 per square foot of space that you use as your office.
If you have a 100-square-foot office, you get a $500 annual deduction. The most you can claim under the simplified option is 300 square feet.
The simplified option significantly reduces the burden of recordkeeping by allowing a qualified taxpayer who uses this method to multiply a prescribed rate times the allowed square footage of the office.
You don’t have to keep records of your bills, home depreciation, or other expenses under the simplified method.
Taxpayers using the regular method must determine the actual expenses related to running a home office. These expenses might include mortgage interest, insurance premiums, utility bills, repairs, real estate taxes, and depreciation of the property used as a home office.
When using the regular method, taxpayers generally deduct the percentage of their home used for business purposes. For example, if you have a 1,000 square foot house and 100 square foot office, you’d deduct 10% of your qualified expenses of maintaining your home.
If you use itemized deductions, you will need to make adjustments so you’re not double-dipping. For example, if you paid $1,000 in mortgage interest during the year and claimed $100 as part of your home office expenses, you can only include $900 on your itemized deductions.
Which method should I use to calculate my home office deduction?
The first step is doing the math to see which deduction is bigger. It will depend on the size of your office and the costs of maintaining your home.
Next, if the regular method nets you a bigger deduction, decide if the bigger deduction is worth the extra paperwork. Some people want to claim every penny, while others might say that if they’re only saving $X with the regular method, it’s easier to just use the simplified method.
Finally, if you own your home, you need to understand depreciation recapture. Normally, your capital gain on your home is your selling price minus the purchase price.
Since depreciation already deducts part of the purchase price, you can’t deduct the full purchase price when you sell your home. It’s a general tax rule that you can’t claim business deductions and personal deductions for the same expense.
Let’s say you bought your home for $100,000 and sold it for $150,000. Normally, you’d have a $50,000 capital gain. However, if you took $10,000 in depreciation, your capital gain is increased to $60,000.
Depreciation also means that if you qualify for the capital gain exclusion on a home sale ($250,000 or $500,000 for joint filers), you lose part of the exclusion.
In the above example, a $60,000 gain would normally fall under the exclusion. Since you took $10,000 in depreciation, the $10,000 doesn’t fall under the exclusion, and you’ll owe taxes on that amount.
The IRS also says you can’t skip claiming depreciation if you choose to use the regular expense method.
Requirements to Claim the Home Office Deduction
The home office deduction rules have two main requirements to determine if you qualify.
- First, you must be using your house regularly and exclusively for business purposes.
- Second, your principal place of business must be located in your house.
Regular and Exclusive Use
Your home office must be used exclusively and regularly by you or someone else who works in your business. You can’t allow others to use it for reasons not related to your business.
You can never use your home office for any other reason, and the IRS is very strict on this. Even if you work in your home office 40+ hours per week, you can’t do things like let your kids play video games in your office on the weekend.
The office can be a section of a larger room as long as the office section is reserved for your exclusive use.
Principal Place of Your Business
Principal place of business means an important part of your business but not necessarily the only part.
If you maintain an office elsewhere and perform the same tasks in your home office out of convenience, your home office is generally not deductible. This applies even if your office isn’t exclusively yours such as a coworking location.
If you have multiple business locations for different reasons, such as using your home office as the place you do your office work and having a medical office where you see patients, you can generally deduct your home office.
Other possible uses include storage space, retail store locations, places for client meetings, or places for producing videos.
What does home mean for the purposes of the home office deduction?
A home includes a house, apartment, condo, mobile home, or other dwelling that you live in where your office is part of that dwelling.
Outside structures are potentially eligible for the home office deduction. Outside structures include things like an unattached carport, shed, garage, barn, studio, or greenhouse.
If you use the outside structure as an office, you can typically deduct it under the home office deduction rules.
The IRS expressly disallows the home office deduction for any part of your property used exclusively for a hotel, motel, or other business. If you have a structure that you use for another business use that wouldn’t normally be considered an office, ask your accountant what to do.
How often does the IRS audit home office deductions?
The home office deduction is a common target of IRS audits because people often don’t follow the rules or even completely make up this deduction.
If you use the simplified method, you may want to save pictures of your home office, especially if you change where your office is or move houses. Be ready to explain to the IRS how you use your office.
If you use the regular method, do the above and keep receipts for all expenses that you claim.
IRS audits can be annoying, but they’re really only trying to make sure people pay the right amount of tax. Don’t skip hundreds of dollars in legitimate deductions because you might have to answer an IRS letter.