It is estimated that over 40 million Americans work from home at least some of the time and with each passing year that number continues to grow. In today’s world computers, smartphones and high-speed internet access make it easier and oftentimes more profitable to operate from a home office. 60% of all small businesses with no paid employees are home-based and generate billions of dollars in Revenue as reported by the US small business administration.
Generally speaking the cost of owning or renting your home is a personal expense and except in certain circumstances you cannot deduct personal expenses. However, if you use a certain portion of your home for business and you are self-employed you may be able to deduct a number of expenses including rent or depreciation, mortgage and real estate taxes, maintenance, and even utilities.
In 2015 schedule C filers claimed home office deductions in excess of 9.8 billion dollars.
you may take the home office deduction in the form of actual expenses or an allowance according to the IRS set amount commonly known as the simplified method whichever type of write-off method you choose the result is a home office deduction.
Here we will cover home office expenses however you do not need to use your home as an office to claim the seduction home office is simply a name assigned to the category of business expenses we will discuss.
The home office deduction has oftentimes been thought of as a red flag for an audit however there is no statistical data to support this theory. If you meet the requirements for the home office deduction and you have proof of your expenses you should have nothing to worry about even if your tax return is audited.
Home Office Deductions in General
No matter if you own your home or rent it you may be able to deduct a portion of the cost of your home if you use it for business. The law is very strict on what is considered business use of home. First of all you must use a portion of your home exclusively and regularly for your business. Additionally the home office must be one of the following:
1 your principal place of business
2 a place to meet or deal with clients or customers in the normal course of your business
3 a separate structure not attached to your residence That is used in connection with your business exclusively and regularly
Exclusive use of a home office means that it is used only for your business activities and not for personal purposes of any kind. For example, if you have a spare bedroom that you have equipped with a computer telephone and file a cabinet you did not meet the exclusive use test for a home office deduction if you also use that room as a guest room or Family Den. The kitchen will never qualify even though it is used for legitimate business purposes because it is also used for personal reasons. The exclusive use test does not require you to set aside an entire room for business purposes however it must be a separately identifiable space. You are not required to mark off a separate area by a permanent partition. Even occasional use of a space by Family relatives or other guests prevent a taxpayer from meeting the exclusive use test.
The home office must also be used on a regular basis for your business activity and many facts and circumstances will apply. There is no minimum number of hours to work to meet this requirement.
Principal Place of Business
Your home office is treated as your principal place of business if it is a place where you can work your business. This can be your Prime business just a side Hustle. as long as it is the main location for your particular business it is your principal place of business. Your home office is also considered to be your principal place of business if it is used for substantial managerial or administrative activities and there is no other fixed location for such activities.
Example: our favorite local realtor Debra runs all over town visiting clients showing properties and marketing. Deborah uses her home office to schedule appointments, keep her books, records and other administrative duties. she can treat her home office as her principal place of business because she uses it for substantial managerial and administrative activities. she’s not required to have a storefront or other office space for such work.
examples of substantial administrative or management activities include:
keeping books and Records
ordering supplies
inputting multiple listings on her computer
schedule an appointment
email marketing
More than One Business
If you are an employee at another company and also conduct a side business such as a Realtor from a home office you made it back to your home office expenses for the side business. The business activity from the home office does not need to be your main activity, it simply must be the Principal place of business for that particular activity.
Place to meet or deal with clients
If you meet with a client in a home office you can deduct home office expenses. The office you can conduct business at another location including an office, and your home office can be recognized as a satellite office. If you use your home office to receive or make phone calls to clients on an occasional basis you do not meet this test. This test generally allows professionals such as Realtors to deduct home office expenses even though they have another office they can still use a home office and deduct all related expenses it simply must be on a regular basis and not on an occasional use basis. Once again to meet these requirements the home office must be used exclusively for business and cannot be used for personal activities during the time when it is not used for business.
Actual Expenses or Simplified Method
There are two separate ways in which you can calculate your home office expenses: the actual expenses method or the simplified method. Furthermore you can change your election from year to year.
By using the actual expense method you will most likely be able to deduct a greater dollar amount. If your home office space is greater than 300 square feet if you have unusually high utility costs or other expenses related to the home office the actual expense method will usually be most beneficial to you.
The simplified method is most beneficial because if Realtors want to eliminate time-consuming record-keeping and can simply rely on the IRS set deduction amount for your home office. you do not have to track and retain records showing what you paid for electricity and other expenses that are part of the home office deduction. Additionally, text prep time is greatly reduced by using the simplified method.
Actual Expense Method
If you deduct the actual expenses related to your home office some expenses are directly related to your business use and are fully deductible. For example if you choose to replace the carpet in your home office the entire cost of that new carpeting is a business expense. Other expenses you will incur are defined as being indirect expenses. These expenses relate to your entire home and therefore only a portion of them will be deductible as a home office expense. some of these indirect expenses are:
mortgage interest or your rent
property taxes
Utilities
Insurance
repairs to the home such as heating or air-conditioning
Security
systems
Cleaning
Only a portion of indirect expenses related to the businesses to your home are deductible. So allocate the appropriate amount of expenses? let’s say you have four rooms in your home and you use one for business you can allocate 25% of the expenses for the business if all the rooms in the home are approximately the same size. more accurately divide the square footage of your home office by the square footage of your home use this percentage to determine the amount of indirect expenses.
Example: Debra a local realtor lives in a home that is 2000 square feet. Her home office is 200 square feet. therefore her home office use is 10%.
Example 2: local realtor Steve has determined his business percentage is 20%. His property taxes for the year are $5,000. Steve may take $1,000 as part of his home office deduction ($5,000 X 20% = $1,000).
The person of your mortgage interest not treated as part of your home office deduction continues to be deductible as an itemized deduction on schedule A.
In most instances utility expenses such as electricity gas trash removal are all treated as indirect expenses. The business portion is part of your home office deduction; the non-business portion is not deductible in some rare instances. If you can show that a particular use of your home office is greater than the allocated percentage of the whole bill you can claim that additional amount as a direct expense.
The business portion of a homeowner’s insurance policy is part of your home office deduction; this is considered a direct expense. Oftentimes you make Curie special coverage for your home office equipment, this additional coverage is also a direct expense.
Repairs and maintenance may be considered direct or indirect expenses depending on their nature. a repair to the air conditioning unit is an indirect expense. replacing the carpet in the home office itself is a direct expense.
Non-deductible expenses
Ultimately you will incur some expenses that will not be deductible in any circumstance. for example because of landscaping our pool maintenance is not a home office expense
Limitations
Your home office deduction can never exceed your gross income from the home office activity.
Simplified method
Rather than using the actual cost of the home that relates to the home office the IRS has created a simplified method. This method lets you deduct up to $5 per square foot for up to 300 square feet of your home office. Therefore the maximum deduction is $1,500 ($5 X 300 Square feet). If the space you use for your home office is smaller than 300 square feet your deduction will be less than $1,500.
To use the simplified method the basic home office deduction rules still apply. you must use the space regularly and exclusively for business and that the home office is your principal place of business.
If the home office is used for only a portion of the year then you must prorate the deduction for the year.
Example: A newly licensed Realtor, James, sets up his home office on August 1st of the year. He may deduct $400 ($1,500/12 months X 4 months).
Depreciation
If the simplified method is used for the home office in the home that you own you cannot deduct an allowance for depreciation and no basis adjustments to the home is required.
Another benefit
Home office deductions means having more than simply deducting the expenses related to the office for example having a home office means that traveling to and from the office is fully deductible this includes traveling to a satellite office. traveling from your home to a customer’s location and back again is a fully deductible business expense.
If you would like to take the standard deduction on your schedule A, you are still able to take the mortgage interest deduction and property tax for the home office expense.
Home office deductions on the sale of your home
Claiming your home office deduction does not impact your ability to claim the home sale exclusion (up to $250,000 gain individually or $500,000 on a joint return). however any depreciation taken on your home office must be recaptured at a rate of 25%. you cannot use your home sale exclusion to offset this tax. furthermore you cannot avoid this recapture by choosing not to report depreciation to which you are entitled to when you use the actual expense method. recapture applies to depreciation both allowed and allowable whether or not you claimed it. If you prefer to avoid depreciation recapture you must disqualify yourself entirely for your home office deduction; this can be easily done by not using the space exclusively for business. I just want to find your home office deduction. You will in fact lose out on depreciation but you can still claim many related expenses such as ordinary and necessary business expenses.
Where to deduct home office expense
Self-employed individuals will compute their home office deductions IRS form 8829 expenses for business use of home. This one allows you to calculate the portion of your home used for business. It is used to allocate your home related expenses based on a percentage you also use the form to calculate any carry-over of unused home office expenses.
The home office deduction calculated on form 8829 is then entered onto a specific line on Schedule C for expenses for business use of your home.