Even though we don’t currently prepare tax returns for clients at my financial planning firm, tax is a topic that comes up a lot. Many of our clients own businesses, and most of them share two opinions:
- They really dislike paying taxes
- They want to figure out how to pay less each year
Alongside that there are several tax related questions that come up fairly frequently with our clients. One of them is the home office deduction. How can you take it? Are you even eligible? What can do to take a larger home office deduction this year? What are your options?
Whereas employees and small business owners alike were eligible to take the deduction prior to 2018, the Tax Cut & Jobs Act eliminated home office expenses as a miscellaneous itemized deduction. That means that rather than deducting home office expenses on Schedule A as an itemized deduction, they’re now claimed on Schedule C. And since Schedule C only contains information related to self-employment, the tax law change essentially means that employees are no longer eligible to take the deduction.
For business owners still eligible to take the home office deduction, there are two options for calculating the amount: the simplified method and the actual expense method. This post will cover both in detail, and explain what you need to know to take the deduction yourself.
Am I Eligible to Take the Home Office Deduction?
Before you spend time working the numbers on how much the home office deduction might actually save you, you’ll need to determine whether you’re actually eligible for it in the first place. To take the deduction, two criteria must be met:
- Exclusive & regular use
- Principal place of business.
Exclusive use means that a portion of your home must be set aside exclusively for business activities. This could be a separate room as a dedicated office, a desk in your garage, or any other physical set up that you use for business activities only.
The IRS does not mess around with the exclusive use requirement. While you’re entitled to take care of some personal business from your home office just like you would in a typical office setting (taking personal calls, etc.), they cannot be excessive. Noodling on the guitar, letting your kids play video games, or other home activities taking place in your home office would clearly be over the line.
Your home office must also pass the regular use test. There’s no specific definition here, but it’s another area where you don’t want to be too aggressive. Using a bona fide home office a couple hours each day is likely acceptable. Making business calls for 45 minutes twice a week may not be.
Secondly, if your home office is not in an unattached structure (like a stand alone garage), it must pass the principal place of business test. This means that your office must either be the principal location of the business or a place where you regularly meet with customers/clients. It also means that your office must be your actual office – not just a convenient space at your home – to be deductible. If the space is in an unattached structure you’re not required to meet this criteria to be eligible for the deduction.
Principal place of business is not synonymous with your principal office. As long as you’re using the home office to conduct essential management activities that are not conducted anywhere else, the office could theoretically be a principal place of business.
Keep in mind that this could work for side gig income too. Say you’re an employee of a big company from nine to five, but spend a few hours a week on an unrelated side business. As long as the activities pass the criteria mentioned above, you’re probably able to deduct the space as a business expense.
Calculating the Deduction: The Simplified Method
If you meet the criteria above, you’ll have two choices for calculating the deduction: the simplified method and the actual expense method. The simplified method takes the square footage of your home office (with a maximum of 300 square feet), and multiplies it by a rate prescribed by the IRS. The rate for 2019 is $5 per square foot.
For example, if you have a 10 foot by 10 foot room in your house that’s set up as your home office, you’d be free to claim a $500 deduction using the simplified method: 10 * 10 * $5 = $500.
Calculating the Deduction: The Actual Expense Method
The more time intensive (but also more exact) option is the actual expense method. Rather than multiplying the footage by an IRS prescribed rate, with this method you’re deducting the actual expenses resulting from your home office. To do so, you’ll start by dividing the square footage of your home office space by the entire square footage of your home. You will then use this ratio to report your home office expenses on Form 8829 (“Expenses for Business Use of Your Home”).
For example, if your home office takes up 200 square feet in a 2500 square foot home, the office constitutes 8% of your home. Knowing this, you may claim 8% of various household expenses as indirect business use expenses. All of the following are eligible:
- Homeowner’s insurance
- HOA fees
Note that if you own your home, you won’t be deducting rental payments. Instead, you’re free to depreciate the portion of your house used for your home office. (It also means you’d need to claim prior depreciation as gains if you ever sold the home).
You may also deduct direct home office expenses, in addition to the indirect expenses listed above. Remodeling or painting your home office, for example, would be an eligible direct expense. And since they don’t apply to the entire household, you don’t need to split the costs between the portion of your home used for your office and everything else.
Other Thoughts on the Home Office Deduction
There is a rumor out there that claiming the home office deduction comes with a significant amount of audit risk. I’ve heard from multiple people who are eligible for the deduction that they’re reluctant to take it, fearing that doing so would come with an audit attached. That may have been true years ago, but it’s no longer the case based on what I’m hearing from CPA friends. If you’re entitled to take the home office deduction, take it. There’s no legitimate reason not to.
You don’t want to be too aggressive with it, though. Make sure you’re able to satisfy the exclusive & regular use and principal place of business tests, and do NOT step over the line.