There’s more interest in the Home Office Deduction than ever before and justifiably so. With the ‘great resignation’, there has been the ‘great formation’. More Americans than ever have a home office with a side-hustle or a full-time business operation!
As such, millions of Americans are wondering if there could be a tax deduction in all of this for the ‘wear and tear’ on their floors, furniture, and refrigerator.
Good News and Bad News about Home Office Deductions
First, the bad news. If you are an employee, and don’t have a business, you don’t qualify for the home office deduction. Sorry!
Under current U.S. tax law, there is no longer a deduction for ‘unreimbursed employee expenses’. This means that when you are forced to work from home and paid as an employee with a W-2, there’s no write-off for the cost of you sharing your home supplies, equipment or space. However…there are options.
If you can talk your employer into it, they could reimburse you for the ‘cost’ of you sharing your home as a new company workspace. Those reimbursements are typically tax-free. The company gets a tax deduction and you, the employee, get a tax-free reimbursement from your company. That’s right – you don’t have to include the income on your tax return.
However, if any of those funds exceed a fair ‘cost’ reimbursement, it could turn into rental income. It could possibly even be included in your W-2 (you want to avoid either of those issues if possible). Make sure to talk with your employer about the options for the amount and how to categorize it properly.
Great News for a Home Office Deduction
The best option and good news is that if you have any type of small business or side gig you are likely to qualify for the home office deduction.
If you have a side-hustle, small business or even rental property, taking the home office deduction opens the door to many powerful write-offs.
A side gig would include anything from driving for Uber, selling a product online, providing a service business, or part-time consulting. If you receive any type of 1099-NEC, that’s code for “Small Business”.
Dispelling the Myth that it’s a Risky Deduction
Bottom line, it’s not a risk to take the home office deduction. If you’re entitled to it, it’s a risk not to take it – period!!
Just make sure to use the proper method.
Another Reason to take the Home Office Deduction – Your Auto!
There’s another incredible reason for even a conservative home office deduction: it opens the door to the auto deduction!
Think about it. Mileage commuting to and from work, as well as the personal use of your vehicle is not a write-off. However, if you have a “home office” (no matter how small) for your side-gig (aka. small business)…you can now justify writing off the mileage when leaving your home office to pursue business tasks and errands.
Two (2) Requirements to Claim the Home Office Deduction
Before you can talk about ‘how’ you take the deduction, you want to make sure you ‘can’. There are two basic requirements for your home to qualify as a deduction. You have to meet BOTH of them:
- Regular and Exclusive Use
This is the most difficult test to satisfy and one where the IRS finds most of its leverage. First the technical rule: A taxpayer/business owner must regularly use part of your home exclusively for conducting business.
- Principal Place of Your Business
- There generally must be exclusive use of a portion of the home for conducting business on a regular basis. For example, a taxpayer who uses an extra room to run their business can take a home office deduction only for that extra room so long as it is used both regularly and exclusively in the business.
- The home must generally be the taxpayer’s principal place of business. A taxpayer can also meet this requirement if administrative or management activities are conducted at the home and there is no other location to perform these duties. Therefore, someone who conducts business outside of their home but also uses their home to conduct business may still qualify for a home office deduction.
Thus, the ‘Administrative office’ has evolved to give many taxpayers the option to meet clients/customers at a ‘main office’, but then come home to return email, billing, do the books, and various other administrative tasks.
TIP– If you have multiple businesses, i.e. a rental property business, use the home office deduction for this business and leave it alone for your primary or operational business.
Two (2) Options to Calculate the Home Office Deduction
Generally, deductions for a home office are based on the percentage of your home devoted to business use. However, the IRS has now come up with another option for completing the actual ‘calculation’.
- Simplified Option.
The simplified option can significantly reduce the recordkeeping burden by allowing a qualified taxpayer to multiply a prescribed rate by the allowable square footage of the office in lieu of determining actual expenses. (Rather than the Regular Method – see below). There are several principal benefits of this relatively new option (since 2014):
- Business owners are allowed to take a deduction of $5 per square foot for the part of their home used for business (a maximum 300 square feet). Essentially $1,500 per year.
- This method still allows business owners to claim their mortgage interest and property taxes as Itemized Deductions on Schedule A without allocating a portion to the Home Office Write-off.
- There is NO requirement to recapture home office depreciation later when you sell your personal residence.
- Regular Method.
This is the better option if you own an expensive residence, home office design, or more square footage. Thus, it’s important to take advantage of the bigger write-off and not settle for the simplified option. However, it also means you have to do math and record-keeping. The issues to consider include:
- Deductions for a home office are based on the percentage of your home devoted to business use multiplied by expenses to maintain the home.
- Allowable expenses include mortgage interest, insurance, utilities, repairs, and depreciation.
- You will be stealing deductions from your Itemized Schedule A deductions in order to maximize the Home Office write-off, but that may not be a bad thing with the new standard deduction limits because you may not qualify to itemize anyway.
- You will have to recapture the depreciation you took for the Home Office when you sell your home in the future.
- And…don’t forget the record-keeping to justify those expenses you are taking.
For those of you operating as S-Corporations, standard industry practice is to calculate a fair home office ‘reimbursement’ amount and take a deduction for rent on the S-Corp tax return. The reimbursement is tax-free to you, and the rent is obviously a tax deduction for the S-Corp. However, a couple of important notes or requirements:
- Make sure the amount of the write-off is not inflated. It would be exactly or at least similar to the amount taken with the home office worksheet for a sole proprietor.
- Consider putting the expense on the 1120S under “office expense”. If you put it on the “rent” line, then the IRS (computer system or auditor) may look for the rent to be claimed on the personal 1040 and you don’t want this to occur. It truly is a ‘reimbursement’ and tax deductible for the S-Corp and tax-free to the individual.
- It’s also critical you have an “Accountable Plan” set forth in your Annual Minutes for your S-Corp. The IRS requires an ‘accountable plan’ for this expense and others when it benefits the employees and/or owners.
- Finally, if you are worried about ‘audit risk’, this is a great way to take the deduction in a much less visible manner and further reduce your chances of an IRS auditor taking an interest in your deduction.
The bottom line is this…having a small business allows you to build wealth AND take advantage of tax deductions that you may not have qualified for otherwise. Moreover, the home-office deduction is just a small part of the overall equation. Talk with your accountant or CPA and insist that they take advantage of this deduction if you are entitled to it. Don’t be talked out of NOT taking it simply because your accountant or CPA is afraid of it.
Download a copy of our home office deduction worksheet under our resources tab.