Many people who previously worked in offices or other places of business now find themselves working from home. And thanks to the pandemic, the gig economy, and other factors, working from home might be on a permanent basis.
But there is a silver lining in working in the cloud. If your workspace qualifies for the home office deduction, you can reduce your taxable income by the costs of working from home. Sole proprietors can claim the home office deduction on Form 8829, which is attached to their federal tax returns. Partners can claim them on Schedule E as unreimbursed partner expenses (UPE) if the partnership agreement expressly states that the partners must pay the expenses personally.
But don’t be too quick to fill out that form. To qualify, your workspace must meet a lot of rules. And the home office deduction is one of the areas that IRS auditors scrutinize the most.
So, What Is A Qualified Home Office?
A workspace in a home qualifies for the home office deduction if it is used regularly and exclusively as:
- The principal place of business (including administrative use),
- A place to meet with customers or clients in the normal course of business, or
- In connection with the business if it is a separate structure that is not attached to the taxpayer’s personal residence.
- A place for storage of inventory or product samples.
- A daycare facility.
Those words regularly and exclusively often trip taxpayers up. Regular use means that the area in question must be used on a continuing basis. You can’t just set up your laptop one time and claim the costs of working in that spot as a home office deduction, even if you don’t use that spot for anything else.
And exclusive use means just that: you can’t use that spot for anything else, ever. Not as a guest room; not as a den; not as your baby’s nursery. It doesn’t have to be physically separated by walls, partitions, tape on the floor or other physical indicators marking the space. But any personal use of the space, regardless of how little room you take up, disqualifies your workspace from the home office deduction. (Daycare use is an exception to this rule.)
But you can use it for multiple businesses, so long as all the business uses qualify. Renting the space to any employer for the employer’s benefit disqualifies the space for all the businesses using it for the home office deduction.
You can also claim a home office deduction for a home office where you perform administrative or management activities if there is no other fixed place where you regularly do them. If you meet with clients in a home office or if it is in a separate structure, you can claim a home office deduction if the home office space is exclusively used for your business.
What Expenses Can You Claim?
You can claim the expenses associated with your home. These generally include:
- Mortgage interest
- Real estate taxes
- Casualty losses
- Home repairs/maintenance
- Security systems
- Garbage removal
- Snow removal
Lawn care and landscaping costs don’t usually qualify for deduction as part of the home office deduction, although the Tax Court has allowed them in some cases.
To deduct these expenses, you must first determine the business percentage of your home. You can use any reasonable method to do this, such as the number of rooms (if they’re of comparable sizes) or square footage used regularly and exclusively for your business. The business percentage equals the business portion of your home divided by the total space of your home.
Then determine whether the expenses are direct or indirect expenses. Direct expenses benefit only the business portion of the home. Indirect expenses benefit the entire home. You can claim 100% of direct expenses and the business percentage of indirect expenses. You can also claim the non-business percentage of mortgage interest, real estate taxes and casualty losses as itemized deductions on Schedule A. (The non-business percentage of other home-associated costs are nondeductible.)
The business percentage of qualified residence interest, real estate taxes and casualty losses is fully deductible. They can create a net loss on Schedule C. However, the deduction for other home-associated costs is limited to the business’s income minus allowable deductions. If there is more than one place of business, only gross income from business use of the home is counted for determining this limitation. Disallowed costs are carried forward to the following year.
Home offices are depreciated over 39 years. The date the office is placed in service is the date the home is first used for business, not the purchase or acquisition date of the home itself. The depreciable basis of the home office is the lesser of the home’s cost or fair market value when placed in service. The cost or fair market value of land is excluded from the depreciable basis.
The Simplified Method
If all the rules above have you feeling overwhelmed, you can relax. There is a simplified method for computing the home office deduction.
The criteria for claiming a home office deduction remains the same as those listed above. To use the simplified method, multiply $5 by the home’s square footage you use for qualified business use. Report the deduction on Schedule C, line 30. Form 8829 is not used for the simplified method.
If you use the simplified method, you can still claim the non-business portions of mortgage interest, real estate taxes and casualty losses on Schedule A. But you can’t claim the business portions of these expenses or any other home-associated expenses on Schedule C or F. You also can’t claim depreciation on the portion of your home used for business. And under the simplified method, the home office deduction is limited to net income from the business less other expenses, before any home office deduction.
You can decide on a year-to-year basis whether to use the simplified or regular method of computing your home office deduction. But you can’t claim disallowed expenses from a prior year that were computed using the regular method in a year when you use the simplified method.
If you qualify for a home office deduction, then whichever method you use, you can reduce your taxable income by the allowable business portion of the costs of your home sweet home. That’s nice compensation in a year when we’re working—and staying—at home.