How Does the Home Office Deduction Work?

Sep 28, 2022

For whatever reason there is a lot of confusion among business owners around the home office. From what I understand, accountants often times tell business owners that the home office is an IRS red flag and to avoid it.

We are going to set the record straight here and explain what the home office deduction is and how to claim it in your business.

First things first, the home office is NOT a red flag if you are doing it properly and is actually something that the majority of business owners should be able to take advantage of.

What Qualifies As A Home Office?

There are really two main requirements for your home to qualify for the home office deduction which are:

Used exclusively for business and on a regular basis AND it's a principal place of business.

Lets break these two down a little further:

  • Exclusively for Business and on a Regular Basis
    • Exclusively for Business - This simply means that there is not personal use of the space. You cannot consider your living room that you also watch TV and play with your kids in as your home office.You could use a "portion" of a room as long as you can provide support to prove that portion or section is only for business and never personal. This may come into play if you have a studio apartment setup.
      • Note: If you have "de minimis" personal use it would still qualify.
    • Regular Basis - This simply means that you have to use the space "regularly". If you walk into the space once a quarter, it would not qualify.
  • Principal Place of Business
    • If you meet with clients, customers, patients, etc you of course meet this test.
    • This test use to be harder to meet if you had a separate physical office, but after some tax cases it has become easier to meet due to this idea of an "administrative or management" office.
    • Basically your home office would qualify as a principal place of business if: 
      1. It is used for administrative or management activities and,
      2. There is no other fixed location where substantial administrative or management activities are conducted.
        • Lets say you are a veterinarian you may do all your normal work at you doctors office but if you come home an answer emails, complete bookkeeping, etc then it qualifies for administrative activities.
        • Note: If you do administrative or management activities at another location you would still qualify as long as its not substantial at the other location.

If you look at the requirements, you'll understand that this should essentially open up the door to qualifying for the home office for nearly every business owner. You need to have a space in your home that you use exclusively and regularly for business and you use it for administrative or management activities. 

Easy! Now that we know that you likely qualify lets dig deeper.

How Do I Calculate The Home Office Deduction?

There are two main ways to calculate the home office deduction:

  • Simplified Option
    • $5 per Square Foot of Qualifying Office Space (Maximum of 300 square feet)
      • This method allows you to still claim property taxes and mortgage interest on your personal return should you qualify.
      • If you sell your house with this method you also do not need to recapture any depreciation you may have taken.
  • Actual Method
    • First you need to find your Business Use Percentage (BUP) which is:
      • Home Office Square Footage / Total Square Footage
        • Note: Exclude Common Areas (hallways) to Boost BUP
    • Take your BUP and multiple it by:
      • Mortgage Interest, Property Taxes, Rent, Home Insurance, Utilities, HOA/Condo Dues, Repairs, Maintenance, Depreciation, Garbage Pickup, Security Fees, Lawn Care, etc.
        • Note: If you take itemized deductions this will pull from those and if you sell your house down the road you will need to recapture any depreciation you took.

Lets go through a quick example:

  • Assumptions:
    • Office Square Footage: 250 Square Feet
    • Total Home Square Footage: 2,000 Square Feet
    • Total Expenses: $31,800 per Year
  • Simplified Option
    • 250 Square Feet x $5 per Square Foot = $1,250 Home Office Deduction
  • Actual Method
    • Business Use Percentage (BUP) = 12.5% (250 / 2,000)
    • Costs: $31,800
    • 12.5% (BUP) x $31,800 (Costs): $3,975 Home Office Deduction

As you can see in this example, the actual method provided a much better home office deduction but this will not always be the case. With the actual method there is also more record keeping because you have to keep track of all the various costs. It will also potentially reduce some itemized deductions (if applicable) and may be subject to depreciation recapture down the road if depreciation was taken.

Simply put, do the calculation/estimation and decide which route works better for you!

Now that we know what qualifies as a home office and how to calculate it, lets take it a step further.

Where Do I Claim The Home Office Deduction?

Claiming the deduction will depend on how your business is setup.

  • Sole Proprietor or Single Member LLC: Use Form 8829 (Actual Method) or Directly on Page 1 of Schedule C (Simplified Option)
  • S Corporation: Use an Accountable Plan to reimburse yourself as the owner for use of the office. This will be an expense to the business and not taxable to you as long as you are utilizing an accountable plan.

How Does the Home Office Deduction Work? (Final Thoughts)

  • Hopefully that has helped clear some confusion around home offices and helped you understand why you like should be taking advantage of it
  • A home office is NOT an audit risk if you are doing it right. Just do not get greedy and make sure you document the necessary items to support your deduction.
  • To help prove your deduction keep a log and take photos to record your business use.
  • You can create an office in your home as an administrative office. You can still have an office outside of your home that you do business activities other than administrative activities. This is true even if you spend more hours at your other office as long as the home is where you do the administrative work.
  • BONUS: Claiming a home office deduction enhances your potential automobile expenses and business miles because it takes the non-deductible commuting out of the picture. Your commute is now from your bed to your home office and now when you leave your home for business purposes that is deductible business mileage.
 

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