Deducting Your Home Office on Your Taxes
To topObjective:
- To understand the rules and process for deducting your home office as an expense.
Entities:
- Sole Proprietors
- Partnerships
- Limited Liability Companies (LLCs)
- Corporations
Additional Information:
With more people working remotely than ever before, many are wondering whether they can start deducting their home office as a business expense.
IRS Home Office Requirements
To topThe IRS requires home offices to be used regularly and exclusively for work purposes. Getting your work done on your laptop in the living room is all well and good as far as earning a paycheck goes, but it’s not going to let you make any deductions. You have to actually use this space on a regular basis, too. Infrequent or occasional days spent working at a “home office” in your garage aren’t going to do you any good here, either.
To qualify as a home office, the space will also need to meet at least one of the following requirements:
- The area in question must be the principal place of business;
- Clients, patients, and/or customers come there to meet with you;
- It’s a separate structure; or
- It’s used to regularly store business inventory or related samples and no other place of business exists.
Principal Place of Business
To topYour principal place of business is somewhat subjective but is generally considered to be the centralized location where all the big decisions are made. However, you should also account for the amount of time spent at that location, the importance of the work done there, and whether any of your other locations could reasonably be considered a principal place of business. You don’t need to spend the majority of your workday there, but it should be where you tend to your administrative and managerial responsibilities.
Somewhere to Meet Clients, Patients, and/or Customers
To topIf you use your home office as a meeting place for clients, patients, or potential customers, then it will be deductible even if it doesn’t serve as your principal place of business. Traditionally, videoconferencing was an exception to this, but this could change with the rise of social distancing. These meetings should also be a regular part of doing business and not just a rare convenience.
A Separate Structure
To topUnlike some of the other qualifiers on this list, proving that your home office is a separate structure that is an “accessory or incident to” your home is pretty straightforward. A good example of this would be a carpenter’s woodworking shed kept in the backyard.
Options for Calculating Your Home Office Deduction
To topThere are two ways that you can go about calculating how much to deduct for your home office — the actual-expense method and the simplified method, the latter of which serves as a “safe harbor” option for anyone worried that an accounting error might get the attention of the IRS or other regulatory agencies.
1. Actual-Expense Method
To topYour first option for calculating your home office deduction is to use Form 8829, Expenses for Business Use of Your Home, to sort out the direct and indirect expenses associated with working from home. While direct expenses (such as necessary equipment) are deductible in full, indirect expenses (such as rent, insurance, or certain utilities) can only be deducted in proportion to business use versus personal use. More often than not this comes down the square footage. However, it might be beneficial to use other methods if, for example, your home has more than one room that qualifies as a home office.
No absolute cap exists for how much of your real estate taxes can be deducted for your home office. To calculate how much of your real estate taxes can be deducted, multiply the total tax value by the percentage of your home that contains your home office. For example, if you pay $10,000.00 in real estate taxes and have a home office that takes up 10% of your total space, then you can write off $1,000.00 worth of those taxes under both itemized and standard deductions. You may, however, face some limits when trying to deduct state or local taxes depending on their value when combined with the remaining “personal” real estate tax.
1a. Gross Income Limitation and Carryover
To topYou can’t deduct more money for expenses than your company made in terms of gross income for that year. The leftovers won’t necessarily go to waste, as they can still be deducted next year — but only if you stay under the “Gross Income Limitation.” In other words, be careful not to expense more than you can reasonably expect to be able to deduct on your tax returns.
1b. Indirect Expense Ordering
To topIt’s also important to order your indirect expenses as follows for your deduction to be valid:
- 1. Real estate taxes and mortgage interest.
- 2. Deductible business expenses including repairs, maintenance, insurance, etc.
- 3. Depreciation
2. Simplified Method
To topThere’s also the “simplified method,” which forgoes the record-keeping requirements and advanced math skills typically required by the actual-expense method, and there’s no risk of liability if you make a mistake in your calculations. According to Rev. Proc. 2013-13, taxpayers may deduct up to 300 square feet of the portion of their home used for business at a rate of $5 a square foot. This method has no carryover provision, nor are there any deductions for depreciation. Property taxes, casualty losses, and qualified residence interest, however, can be deducted under Schedule A.
When using the simplified method, all you’ll need to do is apply it to your usual tax return. Once you’ve chosen it, you’ll be locked in for the year. However, you can use a different method on next year’s return without any special statement, as this does not count as a change to your accounting methods. If you have a home office in more than one residence, then you can only use the simplified method to deduct one of those locations. You can’t deduct any disallowed amounts from your last return. Also, if you switch back to actual expenses after using the simplified method, then you’ll need to account for that year’s depreciation table to calculate your property’s depreciation whether or not you used a table for that year.
Home Office Deductions in a Partnership
To topOwners in a partnership might also be able to take advantage of home office deductions. For this to be possible, the partnership agreement must require the partners to pay for their home office and other expenses themselves without compensation from the company. Such expenses will be deducted under Schedule E of your U.S. Individual Income Tax Return as unreimbursed partner expense, or UPE. UPE deductions can be used for both federal income and self-employment taxes. You can use Form 8829 to help calculate the amount that you can deduct.
Home Office Deductions for S Corporations
To topIn an S corporation, shareholder expenses that are not reimbursed are treated as unreimbursed employee expenses, and as such, are no longer deductible. If you own an S corporation, consider setting up an accountable plan in which your home office expenses are reimbursed by the company itself.
Disclaimer: This article is not tax counsel for your business, nor should it be used as such. Please refer to your own CPA for any advice or questions regarding your tax deductions. Information from the Journal of Accountancy.
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