Whether you own a small business, started a side-gig as an independent contractor, or your company now allows you to work from your home, you are always looking for ways to save money on your taxes. After COVID-19 a lot more people are working remotely from home. One of the most popular tax write-offs is the Home Office Deduction. However, this is also one of the most scrutinized IRS deductions.
We’re going to tell you the things you need to know, so you can avoid the IRS, and calculate the maximum home office deduction.
- 3 Rules regarding the Home Office Deduction
- How to Calculate the Home Office Deduction
- Expenses you’re allowed to deduct
- How the IRS audits the Home Office Deduction
- Rules for LLCs and S-Corporations
3 Rules regarding your Home Office Deduction
In order to deduction a portion of your home as a Home Office, you must follow three simple rules:
Rule #1 – Exclusive Use Test. You must use the office exclusively for your business. You cannot use a part of a room that serves another purpose.
- Deductible: Adam has a room that is 12 x 10 (120 sqft.) that is exclusively for his home office. The items in his home office are his desk, computer, file cabinets, telephone, & printer. He doesn’t use this room for anything else
- Non-Deductible: Brad uses his kitchen counter to do work using his laptop. This doesn’t count, since he uses his kitchen counter for both cooking and working. If there is more than one use, it’s not exclusive.
Rule #2 – Regular Use. You must use your home office on a regular and continual basis. If you only use your home office once every 3 months, it’s probably not going to cut it. Examples where the IRS says it counts are: if you use your home office for nightly conversations with clients, or if you use it to meet with clients multiple times a week.
Rule #3 – How you use your home office. If you use your home office as either principal place of business or meeting place for your clients, you may deduct your home office. This also counts if you use your home office for admin or management activities, such as billing customers, bookkeeping, ordering products & supplies, setting up meetings, etc.
How to Calculate your Home Office Deduction
There are two ways to calculate your Home Office Deduction. The simplified method and the regular method.
Regular Method to Calculate your Home Office Deduction
The deduction for your home office is calculated by multiplying your home office expenses times your “business percentage”. There are two methods the IRS mentions that you may use:
- Number of Rooms Method – if all the rooms in your home are about the same size, you can divide the business room by total rooms in the home.
- Square Footage Method – divide the area of the business by your home total square feet
Number of Rooms Method – Adam owns a home that has 9 rooms, and all the rooms are around the same size. Adam’s business percentage is 11.11% (1 divided by 9).
Square Footage Method – Adam owns a home that is 1250 square feet. His home office is 12 x 12 (144 sqft.) Adam’s business percentage is 11.52% (144 divided by 1250).
Let’s assume that Adam’s home expenses are consists of $2,000 a month in rent ($24,000 / year), $5,000 in utilities for the year, and another $500 in other home expenses – this brings the total expenses to $29,500.
Under the Square Footage Method, Adam’s deduction would be $3,398.40 (11.52% x $29,500)
Simplified Method to Calculate your Home Office Deduction
That’s a lot of work to calculate. What if you don’t want to spend the time adding up your monthly bills? No problem, in 2013 the IRS came up with a simple way to calculate your home office deduction. The “Simplified Method” multiplies $5 x the number of square feet of your business office, up to $1,500.
Using Adam as an example, if his home office is 120 square feet, his home office deduction using the simplified method is $600 (120 square feet x $5).
Deductible Home Office Expenses
There are two types of home office expenses that are deductible. They are:
- Direct expenses,
- Indirect expenses
A direct expense is something that is germane only to your home office and not the rest of your home. An example is installing shelves in the home office for documents and files of your business. All direct expenses are 100% deductible.
An indirect expense are expenses that effect the entire home, not just the home office room, such as your monthly electricity bill. These expenses must be multiplied by your home office percentage (%).
Here is a list of all expenses you should look for when you are calculating your home office deduction:
- Mortgage Interest,
- Property Taxes,
- Insurance,
- Rent,
- Renter’s insurance,
- Utilities (Water, Power, Gas, Sewage, Internet, Trash),
- Repairs,
- Security (Ring, Vivant, etc.),
- HOA / Maintenance Fees
Not deductible things are:
- Pool Service (not deductible)
- Lawncare (not deductible)
Don’t forget about Depreciation
If you calculate your home office deduction using the regular method, you must depreciation your home office of the Form 8829.
How the IRS audits your home office
There are a couple things you need to take into consideration when taking the home office deduction.
The first is IRS inspection – once you take a home office deduction, the IRS has the right to inspect your home office. That means that they can come to your home, look inside, inspect the area you claim is your office, take measurements, and then leave. So, if you don’t want them snooping around your home, don’t take the home office deduction.
Capital Gain on Home Office
Second thing you have to consider is that when you calculate your home office deduction using the regular method, when you sell the home, you will have to pick up a capital gain regarding the home office portion. Please make sure to discuss this with your tax return preparer or CPA.
What if I own an interest a LLC, partnership, or S-Corp?
LLCs and Partnerships – You may deduct your home office expenses if you are member of an LLC or Partnership, only if the Operating Agreement expressly states that the partner or member must pay the expenses personally, without getting paid back from the company.
S-Corporations – The only way to get the home office deduction, legally, for your S Corporation is through reimbursements via an Accountable Plan. I will be writing a completely separate article on calculating your home office deduction for S-Corporations with Accountable Plans.
Can employees take the home office deduction?
No. Starting in 2018 through 2025, employees are no longer allowed to take a home office deduction. We were hoping that due to COVID-19 lawmakers would bring back the deduction since so many employees in the workforce are now forced to work from home. Unfortunately, Congress has yet to update the law. We will let you know if it changes.
Married Couples
When you’re, married your home office must still be exclusively used for business. Adam and Betty are married, and Betty runs a jewelry business. She uses half the office for her business. Adam uses the other half for his Star War collection. Since the office doesn’t have 100% business office use, it is no longer deductible. Not even by Betty. Keep the room strictly business!
Multiple businesses
If you have multiple businesses using the same home office, each business must qualify on it’s own merits, otherwise you will lose the deduction for both businesses.
****Please keep in mind that the tax code is constantly being updated and changing. Some of the IRS code and guidance may have changed since the time of this writing. Therefore, this material has been prepared for informational purposes only and is not intended to provide, and should not be relied on for, tax, legal or accounting advice. You should always consult your own tax, legal and accounting advisors before engaging in any transaction(s).