Home Office Deduction Guidelines

James Sikora, II (May, 2017)

Who doesn’t like to work from home? For many people this is a good break in the normal routine that we all have in driving to our offices during rush hour.  For many individuals who run a trade or business from their home, you may be able to claim a home office deduction. The IRS states that in order to qualify for this deduction there is certain criteria that a taxpayer must meet, the IRS provides this guidance under code section 280A.

To qualify for the home office deduction the following criteria must be met.

  1. Exclusively and regularly as your principal place of business
  2. Exclusively and regularly as a place where you meet or deal with patients, clients, or customers in the normal course of your trade or business.
  3. The office can be a separate structure that it not attached to the home, in connection with the trade or business. Examples of a separate structure are a studio, workshop, garage or barn, if you use it exclusively and regularly for your business. It does not have to be your principal place of business, just used exclusively and regularly for the business.
  4. If you have rental property and your office is in your home and it is exclusively and regularly used for business of the rental property you can be eligible for this deduction.  
  5. As a daycare facility, if you are in the trade or business of providing day care to children, persons 65 or older or persons who are physically or mentally unable to care for themselves. You must have been granted a license, or approval as a daycare home under state law.

To meet the exclusive and regular use criteria the taxpayer must use a specific area of the home only for their trade or business purposes.

  1. It can be a room or another separately identifiable space.
  2. The space cannot be used for any personal purposes. For example, if you use and run the company from that office, but your spouse uses that office for the family financials then the office does not meet the exclusive use criteria and you cannot claim the deduction. To meet the regular use test, you must use the home office on a regular basis and, not just for occasional business use.

To meet the trade or business criteria the taxpayer must use the part of the home in connection with a trade or business. If it is used just for a profit-seeking activity then it does not qualify for the deduction.

If the taxpayer is an employee of a company, there are additional criteria that must be meet in order to claim this deduction.

You must meet the following additional criteria:

  1. Your business use must be for the convenience of your employer, and
  2. You must not rent any part of your home to your employer and use the rented portion to perform services as an employee for that employer.

In order to meet the first criteria of being for the convenience of your employer, the home office has to benefit the employer and not the employee. For example, if you have an office that you can go to, but you would rather work from home, this would not be an allowable deduction because it is for the convenience of you and not your employer. But, if your employer requires you to work after hours at your home office and the main office is closed you would be able to claim this deduction because it is at the employer's convenience that you are working when the office is closed. Also, if your employer does not provide you with an office, you are eligible for this deduction.

Now that we have covered who can qualify for this deduction, let's talk about the expenses that can be claimed with this deduction and if there are any limits to those expenses. The first thing that a taxpayer should determine is the business percentage of the dwelling unit that certain expenses will be subject to. To determine this business percentage you take the square footage of your office and divided it by the total square footage of your home. For example, if your office is 240 square feet and your home is 1,200 square feet your business percentage is 20% (240/1,200).

There are three different types of expenses that a taxpayer should know about when determining the deduction. They are direct, indirect and unrelated expenses. Direct expenses are expenses only for the business part of the home, for example, if you repair or remodel your office those would be considered a direct expense and deductible in full.

The second form of expenses, indirect, are expenses that are related to the running of the entire home. Included in these indirect expenses are insurance, utilities, taxes and mortgage interest. These expenses are subject to the business percentage that was calculated earlier.

The third and final form of expenses, unrelated, theses have nothing to do with the part of the home that is used for business. For example, if you remodeled the kitchen those expenses would not be attributable to the home office deduction. Expenses like lawn care and other maintenance are not related to business and cannot be deducted.

The major expense that is indirect and subject to the business percentage is depreciation. You are able to depreciate your home office over 39 years for the general wear and tear that the business causes on the office. In order to determine the depreciation you will need to know the year and month in which you started to use the home for business, the adjusted basis and fair market value of the home (this does not include the cost of the land; land cannot be depreciated) at that time, and any improvements that happened after you began to use the home office. The most important item that needs to be addressed when you depreciate your home office is that you recover the expenses when you sell or dispose of that property. In other words, when you sell your home you will have to "recapture" the entire allowable depreciation, and pay a capital gains tax rate of 25%.

There are limits on how much of a deduction a taxpayer can take against business income. If your business, for example, has $50,000 in income and have other expenses totaling $40,000, leaving you with a net income of $10,000. If you claim the home office deduction and it is $10,000 or less you will be able to claim the full amount. If your home office deduction $15,000 you will only be able to deduct $10,000, with the remaining $5,000 being carryforward to the next tax year.

There is another option available to taxpayers, and that is called the simplified method. This allows taxpayers to deduct $5 per square foot of the home office. The square footage is determined by the smaller of actual area of the home office or 300 square feet. The maximum deduction using this simplified method is $1,500. Using the example above the maximum deduction would be $1,200 (240 x $5). The taxpayer still has to satisfy the requirements previously mentioned and the deduction is also limited based on income like the other method. No depreciation is allowed and the taxpayer does not have to worry about any depreciation recapture when selling their home.

So, if you operate a trade or business out of your home, or are an employee that has a home office, before you deduct any expenses you should know about the home office deduction criteria.  If you have any questions or concerns about your home office and the deductibility of its expenses, please do not hesitate to contact your Dermody, Burke & Brown advisor. 

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