Technology has changed the way people do business. Devices and connectivity allow us to work without actually having to go into the office. Business owners and employees may have the option to work from home. Taxpayers who work from home may be able to claim a home office deduction and reduce their tax liability.
WHO IS ELIGIBLE FOR THE DEDUCTION?
The home office deduction is available to individual taxpayers whether they own or rent the home. The home can be a house, apartment, condominium, mobile home, boat or similar property. The home can also include structures on the property such as a shed, a barn, an unattached garage or studio. It does not include any part of the property which is used exclusively as a hotel, motel, inn or similar business.
WHAT EXPENSES CAN BE DEDUCTED?
A taxpayer can deduct expenses such as mortgage interest, property taxes, insurance, alarm services, utilities, repairs, maintenance, depreciation and rent. Expenses that relate to a separate structure will also qualify for the deduction if all other requirements are satisfied.
REQUIREMENTS TO QUALIFY FOR DEDUCTION
There are two requirements that must be met in order to qualify for the home office deduction. The first is that the home must be the taxpayer’s principal place of business. A taxpayer who conducts business outside the home, but also uses the home to conduct business may still qualify for the home office deduction. In this situation in order to determine whether the home office is the taxpayer’s principal place of business, t
he IRS will consider the relative importance of the activities performed at each place where the business is conducted and the amount of time spent at each place of business.
The second requirement is that the portion of the home being claimed as a home office must be used regularly and exclusively for the business. Thus, the use of the kitchen or dining room as an office would not qualify for a home office deduction even though the room is regularly used to perform administrative tasks for the business because the room is not used exclusively for the business.
Even an employee may qualify for a home office deduction. However, in addition to the two tests above the employee would need to meet additional requirements. The first requirement is that the business use of the home must be for the convenience of the employer. The second requirement is that the employee cannot rent part of the home to the employer and use the rented portion of the home to perform services as an employee for the employer. If the use of the home office is merely helpful to the employer, the employee cannot take a home office deduction.
HOW IS THE DEDUCTION CALCULATED?
There are two methods which can be used to calculate the home office deduction. A taxpayer who qualifies for the home office deduction may choose which method to use in calculating the deduction.
The first method, referred to as the simplified option, allows the taxpayer to deduct $5 a square foot for the business use of the home. The maximum amount allowed under this option is 300 square feet or a $1,500 deduction. With this option all the taxpayer has to prove is the size of the office and that it is regularly and exclusively used to carry on a business. No receipts or documentation are necessary.
The second method, or the regular method, is based on the percentage of the home that is being used as an office and the amount of expenses incurred. Under this method you would need to know the square footage of the home and the square footage of the space being used for the office in order to determine the percentage of the home which is being used for the office.
Once the percentage is determined the home office expenses are separated into direct, indirect and unrelated expenses. Direct expenses are those that are incurred only in the part of the home used for business. For example, the cost of painting the home office or making repairs to the home office. Any direct expenses may be deducted in full. Indirect expenses are those that are incurred in keeping up and running the entire home. For example, utilities, insurance, and property taxes. These expenses would be deductible based on the percentage of the home which is being used for the business. The taxpayer would need to maintain records in order to substantiate the direct and indirect expenses incurred. Unrelated expenses are those that are incurred only in parts of the home not used for business For example, pool or lawn services, and painting and repairing areas of the home not used for business. Unrelated expenses are not deductible.
Because of the potential for abuse, the home office deduction is a red flag for the IRS. Unless the taxpayer can prove regular and exclusive use of a portion of the home, the deduction will be disallowed. Even if regular and exclusive use is proven, the IRS will disallow the deduction if there is no documentary support for the expenses being claimed. Please note that under certain circumstances which are beyond the scope of this article, the home office deduction may affect the calculation of the gain on sale of the home.