Home Office Deduction Rules

Posted on: 10/12/20 by Megan Tan, CPA, CFE, CIA, FCCA

The IRS reminded taxpayers of the home office deduction rules during Small Business Week and urged individuals to consider taking the home office deduction if they qualify. 

Who qualifies for the deduction?

The home office deduction is available to qualifying self-employed taxpayers, independent contractors and those working in the gig economy.  However, the Tax Cuts and Jobs Act suspended the business use of home deduction from 2018 to 2025 for employees.  Hence, employees who receive a paycheck or a W-2 exclusively from an employer are not eligible for the deduction, even if they are currently working from home. 

What is a home office?

Home office expenses are deductible only if:

  1. Taxpayer uses a portion of the home regularly and exclusively for business use; and
  2. The home must be the taxpayer's principal place of business.

A taxpayer must use part of their home for one of the following: 

  • Exclusively and regularly as a principal place of business for trade or business.
  • Exclusively and regularly as a place where patients, clients or customers are met in the normal course of a trade or business.
  • As a separate structure that's not attached to a home that is used exclusively and regularly in connection with a trade or business.
  • On a regular basis for storage of inventory or product samples used in trade or business of selling products at retail or wholesale.
  • For rental use.
  • As a daycare facility.

The term "home" for this deduction purposes:

  • Includes a house, apartment, condominium, mobile home, boat or similar property.
  • Includes structures on the property, like an unattached garage, studio, barn or greenhouse.
  • Does not include any part of the taxpayer's property used exclusively as a hotel, motel, inn or similar business.

Qualified expenses

Home office expenses must be divided into three categories:

  1. Business expenses that are not related to the use of the home (such as advertising, wages and office supplies) are not included in the home office deduction.  Instead, they are deducted on Schedule C.
  2. Direct expenses are expenses that relate only to the rental activity, such as painting or repairs in the home office.  Direct expenses are allocated entirely to the home office. 
  3. Indirect expenses are expenses for maintaining or operating the home.  Indirect expenses must be allocated between personal and business use.  Indirect expenses also must be separated into those:
    • that are deductible without any business used of the home, such as mortgage interest, real estate taxes and casualty losses.  These expenses that are not allocated to the home office are deductible as itemized deductions on Schedule A; and
    • those that are deductible only when the taxpayer has a home office (such as depreciation, property insurance, general repairs, utilities and security systems). These expenses are nondeductible person expenses if they are allocated to nonbusiness use of the home, rather than to home office.  These expenses are nondeductible personal expenses if they are allocated to nonbusiness use of the home, rather than to the home office.

Claiming the deduction

There are two methods for calculating the home office deduction: the regular or simplified method. 

  1. Regular method: expenses must be allocated between the home office and the remainder of the home, based on the business percentage; that is the percentage of the home that is used for the home office.  The taxpayer may use any reasonable method to determine the business percentage, but the most common methods are:
    • Area - the area (the length of the space multiplied by its width) used for home office is divided by the total area of the home.
    • Rooms - if the rooms in the home are all about the same size, the number of rooms used for the home office is divided by the total number of rooms in the home.
  2. Simplified method: under this method, taxpayers simply used a prescribed rate of $5 per square foot of the home office, up to a maximum of 300 square feet.  The home office deduction under the simplified method cannot exceed $1,500.  The IRS may change the $5-per-square-foot rate.  Taxpayer elects the simplified method simply by using it to calculate the home office deduction on a timely filed original return.  The election is irrevocable for the year it is made. 

A taxpayer who uses the simplified method has to determine just three amounts:

  1. total income from the business for which the home office is used;
  2. total deductible business expenses that are not related to the home, such as for advertising, wages paid, and office supplies (these are expenses that are reported on Schedule C); and
  3. the area of the home used as the home office (up to 300 square feet). This is the length of the area times its width.

Caution: home office expenses that exceed gross business income are not deductible under the simplified home office deduction, and they cannot be carried over to other tax years.

Recordkeeping

In order to keep track of income earned and deductible expenses in the sharing economy, it is important to keep accurate records.  Records are also necessary to substantiate business deductions.

For more information, contact your Marvin and Company, P.C. representative.

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