With the economy in a slump, more and more people are trying to take the home office deduction. Unfortunately, most of them don’t actually qualify and are setting themselves up for an audit. If you’ve taken the deduction already or wonder if you’re eligible, here’s what you need to know so you can have all your information ready for next April’s taxes.
Who Qualifies for the Home Office Deduction
Just because you have an office at home, that doesn’t mean you qualify. In order to be considered a home office, it must be regularly and exclusively used as a principal place of business, which can include administrative work or meeting with clients. You can also use the space for business equipment storage. There are special rules for daycares, so contact a tax attorney for advice if you operate one out of your home.
If you take the deduction, you can’t have another fixed place of business, however there are some exceptions if the office is in a separate structure not attached to your home. The IRS publication gives the example of a florist who has a greenhouse in the backyard.
Regular and Exclusive Use
In order to be considered “regular use,” you must use it regularly to conduct your business. You can conduct business off-site if that’s the nature of your business, but you should use the home office for billing, recordkeeping, etc.
“Exclusive use” means exactly that. You can’t use the business area for personal use. That means no playroom, no guest room, no business conducted at the dining room table, nothing. Of course, it doesn’t have to be a whole room. You could only deduct the desk portion of the room and that would probably be fine.
If you operate two businesses out of your home, then both of the businesses must meet the exclusive use test.
The Employee Deduction
In general, employees of another company don’t qualify for the deduction. There are exceptions, but it’s tricky. You must use the home office for the convenience of your employer and not have an office that is supplied to you by your employer at their place of business. Typically the employer must require you to work at home. For example, if you telecommute a couple days a week for your convenience, but could go into the office then you don’t qualify. If you telecommute because your employer doesn’t maintain an office, then you qualify, but the exclusive and regular use tests still also apply.
You also may not rent a portion of your home to your employer and then conduct business for the employer in that space and deduct the cost of it.
Calculating the Deduction
If you’re self-employed, then you can only deduct up to the amount of your gross receipts. So, if you earn $6,000, your home office deduction plus deductions for other business expenses can’t exceed $6,000. If you have more deductions, you can carry the remaining deduction forward to the next year, but it must still meet the deduction limit then.
To find the amount you can deduct, measure the length and width of your office, or the space in your home where you exclusively conduct your business. Now divide that number by the total square footage of your home. The IRS example gives the example of a 240 foot business use in a 1200 square foot home. You can deduct 20% of the following, up to the limit of your gross receipts:
- Mortgage interest
- Real estate taxes
- Repairs (if the repairs affect that portion of the home.)
The IRS example shows the following example:
Gross receipts: $6000
Taxes and interest: $3000
Business expenses: $2000
Deduction limit: $1000
Utilities, insurance: $800
Excess: $1400 that can be carried over to the next year.
You can write off depreciation for the value of the portion of the home used for business due to wear and tear, but only that portion and not the land or the rest of the house.
If you have physical property, like a computer, that that you use for your business, you must use it at least 50% of the time for business in order to take a deduction for the depreciation.
Gain on the Sale of the Home
If the home office is attached to your home, then you don’t have to report the depreciation when you sell the home at a profit. If the office is a detached structure, then you must report the profit. Contact a tax attorney for advice in that case.
The home office deduction is a tricky thing. It’s not guaranteed to get you an audit, but it can be a red flag if you don’t earn much from your business and write off a lot of home office costs, or if you don’t operate a business and claim the deduction as an employee. If you plan to take the deduction and have a difficult time making the case, then it’s best to contact a tax attorney for advice. If you’d like a quick check, use this home office deduction calculator.