One of the best and often overlooked tax deductions is the home office tax deduction. While this won’t reduce your IRS payment to zero, it can still provide a lot of added value, especially for those working from home or running a business out of their spare bedroom. Just make sure to use it correctly. If you are eligible for home office deductions, the tax savings can be well worth the additional work required to qualify.
Many people whose small businesses qualify them for a home office deduction are afraid to take it because they’ve heard it will trigger an audit. But if you deserve it, take advantage. These tips can help you determine if you qualify and rest easy when you do.
Will a home office deduction trigger an audit? The answer is generally “no.” Changes in the rules in the late 1990s made it easier for people who work out of their homes to qualify for these write-offs. So if you qualify, by all means, take it.
For starters, it requires no additional outlay. Unlike many other deductions that require you to invest in something or spend additional money in order to qualify, the home office deduction does not. It is just a matter of shifting perspective. What you would normally see as a non-deductible expense, such as a business-related internet bill or new printer, could indeed be a write-off. Take some time to think about items that you also use for business that could fall into this newly discovered category.
1. Exclusive and regular use
The biggest roadblock to qualifying for these deductions is that you must use a portion of your home exclusively and regularly for your business. The office is generally in a separate room or group of rooms, but it can be a section of a room if the division is clear—thanks to a partition, perhaps—and you can show that personal activities are excluded from the business section. For example, if you happen to do work in your dining room but also eat dinner here every night, it would not qualify. The law is clear and the IRS is serious about the exclusive-use requirement. This space needs to be used for business activities and nothing else. There are exceptions, for example if you are running a licensed day care facility, but when in doubt consult your accountant.
2. Principal place of business
In addition to passing the exclusive- and regular-use tests, your home office must be either the principal location of that business, or a place where you regularly meet with customers or clients. If you are an employee and have a part-time business based in your home, you can pass this test even if you spend much more time at the office where you work as an employee.
There is, though, the question of what constitutes a business. Making money from your efforts is a prerequisite, but for purposes of this tax break, profit alone isn’t necessarily enough. If you use your den solely to take care of your personal investment portfolio, you can’t claim home office deductions because your activities as an investor don’t qualify as a business.
Taxpayers who use a home office exclusively to actively manage several rental properties they own, though, may qualify for home office tax status—as property managers rather than investors. As with the regular-use test, whether your endeavors qualify as a business depends on the circumstances. The more substantial the activities, in terms of time and effort invested and income generated, the more likely you are to pass the test.
As long as you at least use the home office to conduct your administrative or management chores and you don’t make substantial use of any other fixed location to conduct those tasks, you can pass this test. This rule makes it much easier to claim home office deductions for individuals who conduct most of their income-earning activities somewhere else (such as outside salespersons, tradespeople, or professionals).
3. Business percentage of house
Your home office business deductions are based on the percentage of your home used for the business or a simplified square footage calculation.
The most exact way to figure this proportion is to measure the square footage devoted to your home office and find what percentage it is of the total area of your home. If the office measures 150 square feet, for example, and the total area of the house is 1,200 square feet, your business percentage would be 12.5% (150 ÷ 1,200).
An easier way is acceptable if the rooms in your home are all about the same size. In that case, you can figure the business percentage by dividing the number of rooms used in your business by the total number of rooms in the house.
Beginning with 2013 tax returns, the IRS began a simplified option for claiming the deduction. This new method uses a prescribed rate multiplied the allowable square footage used in the home. For 2016 the prescribed rate is $5 per square foot with a maximum of 300 square feet.
Special rules apply if you qualify for home office deductions under the day care exception to the exclusive-use test.
- The home office deduction is not a red flag for an IRS audit.
- Whether you qualify for this deduction is determined each year.
- Deducting a home office is treated differently depending on your business type.
- The simplified method maybe easier but might not provide you with biggest deduction.