As the remote work movement has gained momentum, more and more people are contemplating taking a home office deduction on their taxes. But is it allowed? Self-employed individuals and small-business owners, in particular, can write off some of their expenses on their tax return.
As appealing as it sounds, the home office tax deduction has rules for qualification. In this article, we'll explain everything you need to know about it, including who qualifies, how to calculate it, and the current rules as set by the IRS.
What is a home office tax deduction?
The home office deduction is a tax incentive that allows small-business owners and self-employed individuals to deduct some home expenses from their taxes, if a part of the house is regularly and exclusively used for business purposes. The deduction can be taken from Schedule C of a 1040 Form.
The deductible expenses include:
- Mortgage interest
- Rent
- Utilities
- Insurance
- Depreciation
- Maintenance and repairs
Who qualifies:
- Self-employed individuals
- Freelancers
- Independent contractors
Who doesn’t qualify
If you're an employee of a company who works from home, you don't qualify. “Employees typically receive a Form W-2 and do not qualify, even if they work remotely,” says George Birrell, certified public accountant (CPA) and founder of Taxhub.
Read this next: 1040 vs 1099 Income Tax Forms: What's the Difference?
What are the IRS rules for home office deduction?
For 2023-2024, both homeowners and renters can claim the deduction for any type of home you reside in, including a house, apartment, mobile home, houseboat, or condo. However, your space and activities should also meet the “regular and exclusive use” or “principal place of business” criteria.
Regular and exclusive use rule
The exclusive and regular use rule means a specific area of your home must be exclusively used for business on a regular basis. It could be a room or other “other separately identifiable space,” according to the IRS, but it doesn't need to have a permanent separation. “You must be able to prove that the area serves as your primary place of business,” Birrell says.
Example
You're a freelance writer who uses a room of your home as your office space, from Monday to Friday, on standard working hours. After finishing your work, you watch TV and sleep in a separate room, leaving that office closed until the next morning, when you are going to work again.
Exceptions
You're exempt from the exclusive use rule if you use that space in your home as storage of inventory or product samples. However, it still must be a separate and identifiable space, appropriate for storage, and used as so on a regular basis. You must also sell products at wholesale or retail as your trade or business.
Taxpayers are also exempt from the exclusive use rule if that part of the home is used as a daycare facility. However, you must have the proper license, certification, and registration under state laws. Last but not least, the care service must be provided for children, adults aged 65 or older, and/or physically or mentally individuals who are unable to care for themselves.
Principal place of business rule
The principal place of business rule exists for taxpayers who have more than one business location, one of them being their home. However, your house must be your principal business space. Generally, if you meet or deal with clients, customers, or patients in your home (e.g. lawyer, dentist, doctor), as a regular part of your business, you may qualify for tax deduction.
The IRS has a diagram to help taxpayers verify if they're entitled to a home office deduction under the principal place of business rule. Here it is:
Note: If you have a specific situation that doesn't exactly apply to the situations described above, but believe you may qualify, refer to the full publication published by the Department of Treasury. You'll find dedicated, in-depth sections for daycare, places to meet clients, customers, and patients, and separate structures (e.g. garage, barn, studio).
How to calculate your home office tax deduction
There are two methods to determine your home office deductions: the regular method and the simplified method.
Regular method
With this method, you determine the deduction amount based on the percentage of your home dedicated to your business. For instance, “you can write off 10% of your mortgage interest, utilities, and other expenses if your home office occupies 10% of your house's total square foot,” Birrell says.
In the calculus, you can add direct and indirect expenses. Direct expenses are the ones tied to the business, such as repairing the floor of your home office space. Indirect expenses are the ones that keep the house running as a whole, such as electricity and gas. The 8829 Form can help you figure out the deductible expenses.
For this method, keep track of your expenses by saving receipts and detailed records of bills you paid and purchases you made. This is important because, in case of an IRS audit, you'll be prepared to back up the information on your tax return.
Simplified method
With the simplified home office deduction method, you won't deduct actual expenses. Instead, you'll multiple the square footage of your business space by a predetermined rate. It's a “standard deduction of $5 per square foot of home used for business—maximum 300 square feet,” Birrell says. “Here the maximum home office deduction will be $1,500 (300 sq ft *$5).”
But which one should you use? The simplified method has an easier calculus, the regular method is more complicated and time consuming. However, Birrell recommends using both methods and picking the one with higher results, as it lowers tax liability.
If you move, does anything change?
“If you move, the home office deduction will end for your previous home,” Birrell says. However, if you continue to meet the qualifying requirements in your new palace, you can begin to claim the deductions for that space.
If you're a homeowner and eventually sell your house, your profit may be taxable based on your deduction method of choice. “If you were using the regular method, you may have to deal with depreciation recapture on the old home when you sell it,” Birrell says.
Simply put, if you are a homeowner and use the regular method, you'll be required to depreciate the value of your home and take in home office deductions. When you sell the property, that depreciation percentage may be subject to depreciation recapture (also known as capital gain tax).
For example, let's say you use 10% of your home as business space and deduct the depreciation. When you sell the home, 10% of the profit may be subtracted as capital gain tax. On the other hand, if you use the simplified method, depreciation isn't a factor and homeowners typically aren't subject to depreciation recapture.
Bottom line
The home office deduction is a tax incentive that can save you money on your tax return. But like any matter regarding taxes, there are many rules and specific criteria that can be hard to grasp by yourself. To avoid any problems with the IRS, consider consulting with an accountant and tax advisor.
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