Claiming a Home Office Deduction
Anyone that uses part of their home to conduct business may be eligible to take a home office deduction on their federal income tax return. The requirements are fairly simple and the deductions are reasonably generous.
In this article, we're going to cover the topic of home office tax deductions. As part of that discussion, we'll first outline the qualification rules. Next, we'll provide an example that demonstrates how to go about calculating the portion of a home that can be deducted on a federal income tax return. Finally, we'll quickly review the types of expenses allowed under the home office deduction, and touch on the tax records to maintain.
Home Office Tax Deductions
If a portion of a home is dedicated to business use, then it may be possible to claim a deduction for the expenses associated with that portion of the home. It's not necessary to be self-employed to take this deduction, and homeowners as well as renters may qualify. There are only two requirements outlined by the Internal Revenue Service (IRS).
Qualifications for Home Office Deductions
To qualify for a home office deduction, a taxpayer must meet one of the following requirements:
Exclusive / Regular Use
Part of the home must be used exclusively and regularly to conduct business. This part of the home cannot be used for any other purpose; it must be used on a regular basis to conduct business. In addition to the exclusive and regular use requirement, the home office must be either a principal business location, or one that is used to meet with customers or clients on a regular basis.
If a free-standing structure (such as a garage) is used exclusively and regularly for business purposes, then it's possible to deduct expenses associated with that structure too. This free-standing structure does not have to be the principal place of business for meeting with customers or clients.
Day Care and Storage
The above requirement does not apply if part of the home is used to provide day care services or to store products. For example, if Sam provides day care services from his home from 6:00 a.m. until 6:00 p.m., then he can use that portion of his home for personal activities the remainder of the day and still claim a home office deduction. To qualify for this deduction, the day care business must hold all applicable state and local licenses.Taxpayers may also qualify for a home office deduction if they use a portion of their home for business-related storage. This can include product samples and even business inventory. For example, a spare bedroom might be used to store inventory for an online business. The only caveat here is the home must be the only location of this business.
If someone is an employee of a company, and they meet the above requirements, then the following provisions apply too:
- Business use of a home must be for the convenience of the employer.
- The employee cannot rent any portion of the home to their employer.
- A deduction cannot be taken if the business use of the home is only "appropriate and helpful."
Starting in the tax year 2013, the IRS introduced a simplified approach to home office deductions. It's estimated this will reduce the recordkeeping and paperwork burden by 1.6 million hours per year. Taxpayers that use the traditional percentage of home method are required to complete Form 8829, which involves complex calculations and allocations of expenses. The optional deduction requires the home office owner to complete a relatively simple form.
Optional Home Office Deduction
The optional method allows for a $5 per square foot deduction for up to 300 square feet, thereby capping the total deduction at $1,500 per year. Homeowners electing to use this method can still claim mortgage interest and real estate deductions on Schedule A, but no longer have to allocate these cost between personal and business use of the home.
The above restrictions and qualification requirements are the same under this method.
Percentage of Home Method
There are two ways to determine the business percentage of the home. If all rooms in the home are roughly the same size, then simply divide the number of rooms used for business by the total number of rooms in the home. If two rooms were used for business, and the home had 10 rooms, then 2 / 10 or 20% of the home was used for business purposes.
A second way to determine the business percentage would be to calculate the area of the home used for business, and divide it by the total area of the home. If 250 square feet were used for business purposes, and the home was a total of 2,500 square feet in size, then 250 / 2,500, or 10%, of the home was used for business purposes.
Individuals that run a day care center out of their home need to first calculate the above percentage of the home used to provide this service. Next, they need to calculate the percentage of the year the home is used for day care purposes and multiply that percentage by the above value.
For example, let's assume 500 square feet of a 2,500 square foot home was used five days a week from 6:00 a.m. until 6:00 p.m. to provide day care services. From the above, we know that 500 / 2,500, or 20%, of the home was used for business purposes. Next, we know the home is used 12 hours a day x 5 days a week x 50 weeks a year to provide day care services. There are 8,760 hours in a year, so the home would be used 60 hours a week x 50 weeks, or 3,000 hours per year. The portion of the year would then be 3,000 / 8,760, or 34.2% of the year. In this example, the percentage of business use would be 20% x 34.2%, or 6.8%.
There are three broad categories of expenses allowed for home office deductions:
- Direct Expenses: these are costs directly related to the home office itself. Examples of these direct expenses include painting the home office, and charges for long distance business calls made from the home's telephone. Direct expenses are fully deductible.
- Indirect Expenses: these are expenses associated with running the entire home. Examples include rent, mortgage interest and real estate taxes (although these are normally tax deductible items), general repairs and maintenance (such as replacing a leaking roof), home insurance premiums, electricity, natural gas, fuel oil, trash removal, and cleaning services. Indirect expenses are not fully deductible, and are based on the percentage of the home used for business. If 20% of the home was used for business, then 20% of these indirect expenses are deductible.
- Unrelated Expenses: these are expenses associated with parts of the home that are not used for business purposes. Examples include lawn care services, tree trimming, and direct repairs to non-business portions of the home such as painting a bedroom.
If the percentage of home method is used, it's also possible to take a deduction for the depreciation of the home's value. If the home office was used for the entire calendar year, then the deduction would be:
Deduction = 2.461% x Adjusted Home Value x Business Use (%)
- Business Use (%) = percentage of the home that qualifies as a home office (examples provided earlier).
- Adjusted Home Value = price paid for the home plus permanent improvements.
Finally, there are limits to the amount that can be deducted from a filer's federal income tax liability. Generally, the home office deduction cannot be greater than the business income generated at the home.
Anyone that claims a home office deduction needs to maintain records of all calculations as well as receipts, checks, and other documentation. These records must be maintained for the longer of:
- Two years after the federal income tax was paid
- Three years from the tax return due date or the date the return was filed
About the Author - Claiming a Home Office Deduction