You work from home. You have found a way to squeeze a few more hours out of the day by avoiding a commute. Congratulations! And you are saving money on rent for your office. You can save even more money for your home office by taking advantage of the home office tax deduction when filing your income taxes.
General Rules for Home Office Tax Deductions
Your home office tax deduction must follow very strict rules. The IRS likes to scrutinize this deduction, so taking extra care would be a very good thing. To qualify for this deduction, your home office must be:
- Used exclusively and regularly as your principal place of business, which includes managerial functions such billing, reading reports and keeping books and records or
- Used 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, or
- In the case of a separate structure which is not attached to your home, used in connection with your trade or business, or
- Used on a regular basis for certain storage use, or
- Used as a daycare facility.
If you are an employee, you must add these two rules to those listed above:
- Your business use must be for the convenience of your employer, and
- You cannot rent any portion of your home to your employer and use the rented portion to perform services as an employee for that employer.
Tip: As an employee, it would be advantageous to have something in writing from your employer, stating that your home office is for the employer's convenience and required as a condition of your employment. File that written documentation with your tax return, so that you have it readily available, in case of an IRS inquiry.
If you are a daycare facility, you get an exception to the exclusive-use rule, as long as you meet both of these rules:
- You must be in the trade or business of providing daycare (for various groups of people) and
- You must essentially be licensed to be a daycare center.
Which Method Should I Use?
If you have met the general rules above, the next step is to pick one of two possible methods of computing your home office tax deductions:
- The Simplified Method or
- The Actual Expense Method
The Simplified Method was introduced by the IRS for tax returns beginning in 2013. The computation goes something like this: you determine the actual number of square feet you use exclusively and regularly for your business purpose, not to exceed 300 square feet, then multiply that number by $5, and that will be the amount of your tax deduction.
The Actual Expense Method takes quite a bit more information to determine your home office tax deductions. You will need to gather: home mortgage interest (or rent paid), home insurance, real estate taxes paid, utilities paid, and perhaps original closing papers in order to determine the basis of your home for depreciation purposes.
Determine the square footage of your business space and determine its percentage to the total square footage of your home. This percentage is used on the totals of the home expenses. There may be additional direct expenses of the home business space, such as an additional telephone or DSL line, to use for the home office tax deductions.
Tip: If you are paying a high rate of rent, it may be worth your trouble to use the Actual Expense Method. For instance, if total rent was $36,000 a year, and your percentage of business space was 20%, that would result in a $7,200 deduction for the rental portion of the home office tax deductions.
Home Office Deduction Caveats
- Your home office tax deductions are limited to the amount of income from that business. In other words, you cannot create a losswith the home office deduction.
- When you sell your home, depreciation that you have taken as part of your office tax deductions, will impact the amount of gain that you will need to recognize.
- The home office deduction has historically been a red flag to the IRS.
Additional information can be located in IRS Publication 587. And as always, consult with your tax professional about all your tax needs.
