Home Office Tax Deduction for Home Business
Overview of the Business Use of Your Home Tax Deduction
As a home business owner, you're able to take a variety of tax deductions related to the cost of running your business. This includes expenses incurred operating your business from a home office. There was a time that it was believed that taking the home office deduction would increase the chance of an IRS audit, however, today, over 50 percent of small businesses are run from home, making having a home office common and not a red-flag for the IRS. Nevertheless, the IRS requires that your home office meets specific rules before you can claim the home office deductions.
The best way to stay out of trouble is to only claim the Home Office deduction if you qualify, only to claim the expenses you are entitled to, and to properly document your expenses in case the IRS questions your eligibility or the amount of expenses you attempt to claim. When in doubt, consult a qualified tax professional (best choice) or contact the IRS for clarification - just be sure to document you communications with the IRS.
How to Qualify for the Home Office Deduction
Self-employed individuals who operate a home-business usually find it easy to qualify for the Home Office deductions. In some cases, telecommuters may also qualify to take some of the deductions.
There are two essential requirements you must meet in order to qualify for the deduction:
- You must use the office part of your home regularly and exclusively for business purposes.
- The business part of your home must be either your principal place of business or the location where you meet with clients or customers in the normal course of conducting business. For detached garage or other separate structures, the requirement is only that the building is used in connections with your trade or business. You can also claim deductions if you use an area of your home for storage of inventory or product samples.
Special Requirement for Telecommuters
If you are working at home as an employee of another business, you need to meet the previous tests PLUS:
- Your business use of your home must be for your employer's convenience, AND
- You can't be renting any part of your home to your employer and then use the rented portion to perform services for your employer.
What Is Regular and Exclusive Use to the IRS?
If you have a home office that is in its own room, that you work in continuously, and isn't used for anything else, you meed the "regular and exclusive" rule. However, many home business owners don't have a totally separate and exclusive office. Instead, they have a corner of the kitchen or guest room. Even so, you may still qualify for the deduction.
For example, your dining room table won't qualify if you also eat dinner there, because while you may work there regularly, your table isn't used exclusively for business. However, if you have a desk in the corner of the dining room where you do your work and only your work is done there, you can claim that section of the dining room in the deduction.
What the IRS wants is that your home office space is used as your primary location for doing work, and isn't used for anything else.
IRS Exclusive Use Exceptions
The IRS says that you do not have to meet the exclusive use requirement in either of these two cases:
- You operate a licensed day care center in your home.
- You store inventory or products for sale in your business.
In cases that meet these exceptions, personal use and business use may be mixed. With regard to inventory storage, you can only have mixed use of the area you use for storage if you do not have any other business location besides your home.
What About Working on Location?
Depending on the type of business you run, it's possible that much of your business is done outside of the home. For example, if you're a consultant, you may work in your clients' offices. Or if you do handyman, cleaning, or landscaping services, the work is done at your clients locations. The good news is that if you conduct administrative or management activities of your business solely from your home and no other fixed location, you can still claim the home office deduction.
What Home Office Deductions Are Covered?
If you meet the IRS' requirements for claiming the Home Office deduction on your tax return, you may be able to deduct a percentage of:
- Your real estate property taxes on your home
- Mortgage interest (Be careful not to claim the interest twice - once on Schedule A for your Itemized Deductions and a second time here. Most tax software programs can help with this or use a tax specilist.)
- Your rent payments if you are not a home owner
- Utilities (water, electricity)
- Homeowners or Renter's insurance
- Depreciation on your home (if you own)
- Painting, and repairs. (Permanent improvements are added to the basis of your home for calculating depreciation and you can then recover these if you claim deprecation as part of your Home Office deduction.)
How to Take the Home Office Tax Deduction
The IRS now has two ways to take the home office tax deduction. The easiest is the Simplified Option in which you multiply the square footage of your home office area (not the room but the section used for conducting business) by $5. If you use a 6 ft by 8 ft area of your living room to regularly and exclusively run your business, then you'd multiply 48 (6x8=48 square feet) by $5 to get $240.
The Regular Option is a little more involved, but could result in a greater deduction. In the Regular Option you use the actual expenses incurred in your home office such as mortgage interest, utilities, etc, and multiply it by the percentage of your home the home office occupies. For example, if your home is 1000 square feet and your home office space is 48 square feet, you'd multiply your home expenses by 4.8% to get your deduction. Note that these expenses aren't all business expenses such as marketing costs. Home office expenses are only those related to your home (as listed above).
Disclaimer: I am not a tax specialist or licensed tax attorney. The information provided here should be used as a general guide. For specific questions about your own taxes, please consult a tax specialist or refer to the official IRS publications.
Updated March 2017
Additional Tax Issues for Telecommuters
If you work from home for an employer, you need to meet the requirements that the home business operator meets that have been discussed - regular and exclusive use - no personal use, etc. - except that your working from home has to be for the convenience of your employer. If you employer doesn't provide you with a place to work, as might be the case for a remote call center employee, for example, you probably qualify so long as you don't mix personal use and business use of the area of the home you are claiming. If your employer provides an office for you but you occasionally work from home, you probably won't qualify to take the deductions.
Calculate the Portion of the Home Used Exclusively for Business
Generally, the amount that you can deduct depends on the percentage of your home that is used for business. If you use a bedroom that is 20 feet by 10 feet within a house that has 2,000 square foot of living space, your deduction would be 10 percent (200 divided by 2,000) of your utilities and other deductible expenses. If the rooms in your house, condo or apartment are all about the same size you can use an even easier calculation. For example, if you live in a 4-room apartment and the rooms are approximately the same size and you use one room exclusively for your business you can claim 25 percent of your expenses (1 room divided by 4 rooms).
Other Limitations on Tax Deductions
The deduction will be limited if your gross income from your business is less than your total business expenses. The IRS provides a worksheet you can use to see if your deductions are limited. If so, you can carry some or all of the deductions you weren't allowed to include in this return on next year's return.
Where the Home Office Deduction is Reported
Your Home Office deductions are calculated using IRS Form 8829. The allowable amounts are then transferred to Schedule C, if you are a home business operator, or to Schedule A if you are a telecommuting employee. Therefore, telecommuting employees must itemize deductions in order to claim the Home Office deductions. In some cases, these employees who work from home might find that the standard deduction is a better deal for them even without the Home Office deduction.
A Note About Mortgage Interest and Property Taxes
If you qualify for the Home Office deduction, you'll probably want to claim the portion (percentage) attributable to your home office here instead of taking the full amount on Schedule A in your itemized deduction. So you might list 20 percent of your mortgage and property taxes on Form 8829 and the other 80% on Schedule A. The reason you would want to do this if you are self-employed is because when you transfer the amount to your Schedule C, you are in effect reducing the amount of Social Security taxes (Schedule SE) you'll be required to pay on your business earnings.
Keeping Expense Records and Proving Your Eligibility
If you qualify to take the Home Office deduction be sure to keep good records including photos of your work area you can use to show the IRS your office is used only for business and not in combination with any personal use. You can also have your business mail sent to your home, set up a separate phone line exclusively for business purposes in your home office, and log the time that you spend working at home. You just might save a personal visit from an IRS auditor and avoid other problems, too.
Another Side Benefit of Your Home Office
If your home qualifies as your principal place of business, you can deduct your commuting expenses between your home and another work location. For example, if you are a consultant who has to sometimes work at client locations, you can deduct your commuting expenses to get to and from that location. That's one nice feature that people who don't have a home business would like to have.
Getting More Information on Business Tax Deductions
Although IRS publications can be confusing for most readers, the IRS does provide a great deal of additional information on issues involving the Home Office deduction, including:
- You should make it a point to secure IRS Publication 587 for more details on claiming Home Office tax deductions.
- If you want to claim the business use portion of depreciation on a home that is your primary residence, you will also want to get Publication 551 that discusses Adjusted Basis, which is used in calculating depreciation of your home.
- You'll want Publication 946 if you need to correct inaccurate depreciation deductions in prior years.
- If you plan to sell the home that was the principal location of your business and you've claimed depreciation deductions on the home, you'll want to consult Publication 523, which discusses business use of your home when it's sold (The amounts you deducted in prior years for depreciation could very well end up being taxed as a capital gain when you sell your home.)
Of course, you may decide that all of the hassle and confusion just isn't worth claiming the deduction after all. It might still be worth your while to run the numbers and see what you have to gain if you do claim the full deductions allowable. You may also decide that it's finally worth the expense to hire a qualified tax professional to make your life easier. Again, it would depend on what you stand to gain or lose and if you feel you need a tax accountant for other aspects of your business - usually a very good idea.