Home office expenses are probably the most misunderstood deduction in the entire tax code. For years, taxpayers feared it guaranteed them an audit. Plenty of tax professionals were happy to go along with that myth. (Maybe they thought it made their jobs easier!) But the U.S. Supreme Court made it easier to qualify for the deduction back in 1994, and Congress made it even easier in 2007. So now your deduction is far less likely to attract attention.
Your home office is deductible if:
- It’s your “principal place of business,”
- You use it to meet clients, patients, or prospects in the normal course of your trade or business, or
- It’s a separate structure not attached to your dwelling unit.
Most deductible home offices qualify under Rule #1. IRS Publication 587 says your home office qualifies as your principal place of business if:
- you use it “exclusively and regularly for administrative or management activities of your trade or business,” and
- “you have no other fixed location where you conduct substantial administrative or management activities of your trade or business.”
This is true even if you have another office, so long as you don’t use it more than occasionally for administrative or management activities.
Example: You’re a real estate agent and you have a desk at your broker’s office. Your home office qualifies as your principal place of business so long as you use it to manage your business and keep your books, and you don’t regularly do that at your desk at the broker.
Your home office doesn’t have to be an entire room. You can use part of a room as long as it meets the requirements. You can also claim a workshop, a studio, or any other “separately identifiable” space you use to store products or samples. If you use it for more than one business, both have to qualify to take the deduction.
You have to use your office regularly and exclusively for business. “Regularly” generally means 10-12 hours per week. To prove your deduction, keep a log and take photos to record your business use.
Once you’ve qualified, you can start deducting expenses. If your business is taxed as a proprietorship, you’ll use Form 8829. If you’re taxed as a partnership or corporation, there’s no separate form, which helps you “fly under the radar.”
- Start by calculating the “business use percentage” of your home. You can divide by the number of rooms if they’re roughly equal, or calculate the exact percentage of the home’s square footage the office occupies. If you use the second method, you can exclude common areas like halls and stairs to boost the overall business use percentage.
- Next, you’ll deduct your business use percentage of your rent or your mortgage interest and property taxes. (Deducting those expenses on your business return can save you more than on your personal return. For example, if you’re subject to AMT, you lose your property tax deduction. If your AGI is high enough, the Pease limits cut your itemized deductions. Claiming a home office lets you rescue that lost deduction, at least for the part of the home you use for business.)
- You’ll depreciate the business use percentage of your home’s basis (excluding land) over 39 years as nonresidential property.
- Finally, you’ll deduct your business use percentage of utilities, repairs, insurance, garbage pickup, and security.
Are there any expenses you can allocate directly to your home office? Maybe you spent extra to renovate the room itself. Maybe you have especially high electric bills for home office equipment? You can claim those as “direct” expenses.
You can also deduct the cost of furnishing, carpeting, and decorating your home office. But be reasonable! If you buy a Picasso at auction, you don’t get to deduct it just because it’s in your office!
You can use home office expenses to reduce taxable income and self-employment income from your business, but not below zero. If your home office expenses in a particular year are more than your net income from your business, you can carry forward the difference to future years.
When you sell your home, you’ll have to recapture any depreciation you claimed or could have claimed after May 6, 1997. You can still claim the usual $250,000 or $500,000 tax-free exclusion for space you use for your office unless it’s a “separate dwelling unit.”
If this all seems like too much work, there’s a new “safe harbor” method that lets you claim a flat $5 per square foot (regardless of your actual expenses) for up to 300 square feet of qualifying home office space (regardless of what percentage it occupies in your home). If you use the safe harbor, you’ll continue to deduct your mortgage interest and property tax on Schedule A. However, you’ll forego any depreciation deduction. And if the safe harbor deduction reduces your business income below zero, there’s no carrying forward the loss.
The safe harbor is certainly easier than the traditional method. However, using it might not let you claim nearly as much as the traditional method. The only way to know is to run the numbers and calculate the deduction both ways.
Claiming a home office can also boost your car and truck deductions. That’s because it can minimize or even eliminate nondeductible commuting miles for that business.
Example: You’re a real estate agent with a desk at your broker’s office. If you don’t have a home office, your trip from home to the office is a nondeductible commute. However, if you have a home office, and you start your workday in that office, your “commute” is the trip to the home office, and your trip from home to your desk at the broker is a deductible trip from one business location to another.
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