For those of us who work from home – either for someone else or in our own small business – the home office deduction is a valuable tax break that can save you hundreds of dollars and help defray the upkeep costs of your office.
The IRS allows you to take a deduction for a portion of your home’s expenses – such as rent, electricity, and maintenance – as an expense of your business. However, it’s important to know the rules so you don’t accidentally go overboard – it’s a very commonly abused deduction and some argue is an audit “red flag”.
What Does the IRS Define as a “Home” With a Home Office Deduction?
Basically, if you’re happy living there, the IRS will take your word for it. RVs, houseboats, or underground bunkers can count as a home. You can also use another building on your home’s property such as an unattached garage, if you’ve converted it to an office. The IRS uses two requirements to determine if the area you work can be defined as a home office and be qualified to take the home office deduction.
- You must use the area regularly and exclusively for a trade or business.
- You must be able to show that you use the area as your principal place of business, or meet clients or customers there.
What Does Using an Area “Regularly and Exclusively” mean?
The IRS doesn’t allow you to use the same area for your office as you do for your kids’ playroom, or call the spare bedroom an office because you sometimes take work calls in there. It’s important to have an actual separate space for your office that you frequently use to do work, and that isn’t used for other purposes. Even if this is just a section of the room, if that section is used regularly and exclusively for your work, that is considered a home office, and you can count that square footage in your calculations.
What can be deducted using the home office deduction? Any expense incurred in running your home, such as the rent or your mortgage, utilities such as electricity and gas, necessary repairs, or renters’ or home insurance is part of the calculation. Those expenses are deducted proportionally to the space that the office takes up in the home. We’ll discuss how to calculate that proportion below. However, if you have expenses that were incurred specifically for the home office, such as a repair only to that part of the house, or a phone line that’s used exclusively for the business, you can deduct the full cost of those expenses.
How to Calculate the Home Office Deduction?
The IRS requires you to deduct expenses that affect the whole home proportionally to the amount of the home that makes up your office. In short, you’ll need to determine what percentage of your home’s square footage is taken up by your office. For example, if you own a 1,000 square foot home, and your office is 10×10’, that means your office is 100 square feet – 10% of your home’s square footage is taken up by your office. This is the most common and most accurate method of determining your office’s size. You could also look to the rooms method (if all your rooms are about the same size).
Below is an example of how you would include different expenses in your home office deduction. We’ll use our example above, where the office takes up 10% of the home. Remember that for any expense that affects the whole home (such as heating gas, which presumably heats your entire home and not just the office) you can only deduct the 10% that “belongs” to your home office.
Here are our expenses for the home for the year:
- Rent: $1,100 per month (or $13,200 for 1 year)
- Electricity: $75 per month (or $900 a year)
- Gas: $100 per month (or $1,200 for the year)
- Homeowners Insurance: $100 per month (or $1,200 for the year)
- Furnace Repair: $500
- Total: $17,000
Note: If you are a homeowner (and not renting), then you need to calculate your allowable home office depreciation deduction (and don’t forget you can also deduct a part of your property taxes and mortgage interest). Use your local tax assessors info on your property, and figure out the value of your house/structure is by subtracting the land value from the total assessed property value. In many cases, you use straight line depreciation over 39 years to figure out your yearly depreciation amount (it may be less than 39 depending on when you purchased your home). Then multiply that number with the percentage of your “home” used for business to figure our your yearly depreciation amount.
In our example above, the total expense of renting, heating, and repairing the home for the whole year was $17,000. Because our home office takes up ten percent of the home, the deduction is ten percent of the total expense, which would be $1,700. That’s a pretty nice deduction!
Plus, any repairs made specifically to your office are deducted in full. These types of expenses are called direct expenses.
You may also be able to add in additional space to this deduction if you use areas of the home outside the office for work-related purposes. For example, if you have a retail business that you run out of your spare bedroom, but all the items are stored in the garage, you could deduct the total square footage of both the spare bedroom and the garage as long as you aren’t using either room for any other purpose.
When You Should Not Take the Home Office Deduction?
If you’re renting the space you use in your home to your employer (meaning you’re being paid for your expenses) you can’t also deduct those expenses.
If you have your own office space at work, but choose to work in your home office sometimes for your own convenience.
If you have a home office but also use it for personal purposes.
Publication 587, Business Use Of Your Home, will always contain the most up to date IRS rules on the home office deduction. If you plan to take the deduction each year, you can check this document to ensure that the guidelines haven’t changed. You can also find detailed information on other related topics, such as how to deduct these expenses, and whether you can use a schedule A if you are not a business owner.
If you’re a small business owner or freelancer, every dollar counts. Make sure you’re getting the deductions you’re entitled to! This year, plan ahead and save all of your home-related receipts and bills such as utility statements, property tax bills, receipts for repairs, so that you can add them to your tax files at the end of the year. They are likely to add up to more than you think!