Home Office Tax Deductions: What You Need to Know

Overview: If you use part of your home as an office, chances are good that you may be qualified to score a home office tax deduction. Here’s a quick guide to what can be claimed, how claims are calculated, and how it works!

The onset of COVID-19 has drastically altered the way businesses operate and has forced companies to adopt new working models. Since lockdowns and social distancing made remote work a necessity for many people beginning in 2020, Americans have shifted the way we think about “going to work” in general.

Today, remote working is still the norm for many businesses. The switch to this way of doing work has not only granted greater flexibility to employees — it’s also helped companies reduce their operational expenses. And as an extra benefit, it’s allowed for some excellent opportunities for tax deductions for those in the know.

Many entrepreneurs, solo proprietors, and business owners have turned their homes have revamped their houses and apartments to fit their business needs. As long as they meet the IRS requirements, those who have created a business space in their homes can save big money and claim it as a home expense on their tax returns.

Here’s how you can leverage your home-based business for certain tax deductions that may save you money!

What Is a Home Office Deduction?

Home office tax deductions allow individuals who work from home to claim a portion of their home expenses as a tax deduction. This can include costs such as mortgage interest, property taxes, rent, utilities, insurance, and home repairs. To be eligible for the home office tax deduction, the space must be used exclusively for work and considered the primary business place.

You can claim the deduction whether you’re a homeowner or a renter; you can use the deduction for any type of place where you reside: a single-family home, an apartment, or even a houseboat. However, please note that the rules don’t allow you to use it for a hotel or other temporary lodging.

The home office deduction rules also apply to freestanding structures — such as a studio, garage, or barn space that you use as your home office as long as the structure meets the “exclusive and regular use” requirements.

Here are the conditions you’ll need to meet:

Regular and exclusive use: The space you’re using for your business/work dealings should be exclusively for conducting business conferences and formalities. For instance, using a spare bedroom as your workspace and your kids’ play area makes you ineligible for the home tax office deductions.

However, there are two exceptions — if you provide daycare services for children, handicapped, or elderly individuals in that part of the home, you may probably still claim the business deductions — as long as you own a license, certification, or approval as a daycare center under state law, according to the IRS.

The other exception is if you use that location in your home to store inventory or product samples you sell in a business.

Principal place of business: Although your home office doesn’t have to be the only place where you meet your clients or deal with your customers, it must be your principal place for the business. That means you use the space exclusively and regularly for administrative and business activities — including billing customers, setting up appointments, and keeping related books and records, according to the IRS.

How to Determine Your Home Deduction:

You can determine your home office tax deduction the easy way or the hard way.

The Internal Revenue Service (IRS) offers two methods for calculating the home office deduction: the simplified method and the actual expenses method.

The simplified method is a standard deduction of $5 per square foot of a home office space, with a maximum of 300 square feet. This means the maximum deduction is $1,500 per year. This method is easier to calculate and requires less documentation but may result in a lower deduction than the actual expense method.

The actual expenses method, the more technical of the two, allows individuals to calculate the actual expenses incurred for their home offices, such as mortgage interest, property taxes, rent, utilities, insurance, and home repairs. The individual then calculates the percentage of their home used for business purposes and applies that percentage to their total expenses. For example, if a person uses a room that is 10% of the real square footage of their home as a home office, they can claim 10% of their entire home expenses as a deduction.

You can use Form 8829 to figure out the expenses you can deduct.

Who Qualifies for the Home Office Deduction?

In order to claim a home office tax deduction, individuals must keep detailed records of their home office expenses, including receipts and invoices. Business owners must also demonstrate that the space is used exclusively for work and is their primary place of business. As mentioned earlier, this point refers to the idea that the area must regularly be used for employment, not personal activities.

It’s important to note that the home office tax deduction is only available to self-employed individuals who own their businesses. Employees who work from home — such as freelancers or individual contractors — are not eligible for the home office tax deduction. However, they may qualify for certain expenses reimbursed by their employer through an accountable plan. If this is your situation, try asking your company’s bookkeeping department for more information.

>> Related Reading: Your guide to understanding the top tax deductions for freelancers

Individuals who claim a home office tax deduction may also be subject to self-employment taxes, including Social Security and Medicare. These taxes are calculated based on the net income from the business, and the home office tax deduction can impact the amount of self-employment taxes owed.

What Other Expenses are Deductible?

Various purchases for a home office may be deducted if they’re listed as business expenses on Schedule C. Some examples of home office expenses, possibly deductible, include printers, office chairs, desks, shelves, computers, filing table storage, etc.

Keep track of all your business expenses and receipts to ensure that you can prove your purchase in case of an audit.

>> Related Reading: A complete guide to filing your business taxes

Home-Related Expenses:

Home-related deductions focus on the percentage of your home you use for business purposes. To obtain this number, divide the square footage of your office space by the total square foot of your home. Remember that making accurate calculations is essential only to deduct the appropriate expense percentage.

If you meet the IRS guidelines, you may deduct the following home-related deductions:

Homeowner’s association fee
Homeowner’s Insurance
Mortgage insurance & interests
Utilities, including electricity, internet, heat, and phone
Cleaning services for your office space

Repairs and Maintenance:

If you repair or upgrade your working space, you may also write these expenses off on your taxes. However, the amount you’re writing off largely depends on whether the expense is direct (benefits your home office) or indirect (benefits your entire home).

Thankfully, NOLO’s legal encyclopedia breaks down the differences between direct and indirect home office repairs.

Direct: Let’s say you spent $100 to fix a broken window in your home office — you may deduct the total $100 on your taxes.

Indirect: If you pay $1,000 to repair a leak in the roof of your house, you may only deduct a percentage of that expense equivalent to the quota for your home office.

This also covers the long-term improvements to your home, including complete roof replacement or room renovation.

Things to Watch Out For:

Here are a few things you should watch out for if you plan on deducting actual expenses.

Receipts: Keep detailed records of all the business expenses you think you’ll deduct — including receipts for equipment purchases, utility bills, electric bills, and repairs. So if the IRS ever audits you, you’ll be able to back up your claims.

Beware of the limitations: When claiming a home office tax deduction, it is essential to be aware of the regulations and restrictions imposed by the IRS. For example, the deduction may be within the net income from the business, and any unused portion of the conclusion may not be carried forward to future years.

Home Sales: Individuals who claim a home office tax deduction may be subject to an audit by the IRS. In the event of an audit, the individual must be able to provide documentation and evidence of their home office expenses and use of the space.

Suppose you’re a homeowner taking home office deductions using the actual expenses method. In that case, it’ll cancel out your ability to avoid capital gains tax when selling your primary residence. People who sell their existing residence after having lived in it for about two of the five years before the sale generally don’t have to pay taxes on up to $250,000 in profit on the deal — or $500,000 (for married filing jointly), as per the IRS Publication 523.

In Summary:

The home office tax deduction can be a valuable tool for individuals who work from home, own their businesses, or are self-employed. However, it’s essential to be aware of the eligibility requirements, calculation methods, and limitations imposed by the IRS. Keeping detailed records and documentation of home office expenses is a smart way to claim the deduction successfully and avoid any issues with the IRS.

Do you still have questions? At Prospect Financial Solutions, we’re always up-to-date with current federal and state tax regulations to prepare accurate tax returns for our clients. Get a free consultation for your taxes today!