We are asked very frequently if a taxpayer can deduct the cost of their home that they use for business purposes.
The answer is not always simple and additional information needs to be gathered to determine whether a taxpayer will qualify for the “home office deduction” (HOD).
This article is intended to provide an overview of the HOD and discusses how taxpayers may be able to qualify to take the deduction.
Self-employed taxpayers, not employees, who use all or a portion of their home for business purposes may be eligible to claim deductions if certain conditions are met.
To qualify for the HOD a taxpayer must use their home exclusively and regularly as either 1) the principal place of business for the taxpayer’s business or 2) as a place to meet with patients, clients, or customers in the normal course of business.
Taxpayers don’t necessarily have to own the home to claim the HOD.
For example, if you are renting your home and meet the requirements above then you would be entitled to deduct part of the rent that you pay for your residence.
Taxpayers must use a specific area of the home exclusively for the conduct of the business operations. Taxpayers will automatically fail the exclusivity test above if any area of the home used for business is also used for personal purposes.
There is an exception to the exclusivity rule if the taxpayer uses the home for 1) storage of inventory items, or 2) as a day care facility.
If a taxpayer has more than one business location, including the home, then determining if the taxpayer qualifies for the deduction will be based on a facts and circumstance test.
This test will review the relative importance of activities performed at each location and number of hours spent at each location to determine if the HOD will be an allowable deduction.
Nothing is necessarily easy in the tax code of course so there are a few more exceptions.
First, a taxpayer’s home will be considered the principal place of business if there is no other possible fixed place for them to perform administrative and management tasks of their business.
Second, if a taxpayer meets with clients or patients in their home during the normal course of business then that portion of the home will qualify for the HOD even if the home is not their principal place of business.
In the case of the latter exception, the clients and patients must actually visit the home in person (video conferencing, telephone does not qualify).
How much of a deduction can a taxpayer obtain for the HOD?
The calculation is rather simple and summarized as follows. Take the indirect expenses of the home and multiply those expenses by the ratio of square feet of home used for business divided by the total square feet of the home.
You will be able to deduct in full 100 percent of the direct expenses related to the home office space.
Indirect expenses would be items like insurance, utilities, depreciation, mortgage interest and real estate taxes. Direct expenses would be items like painting or maintaining the area used exclusively for business purposes.
The IRS does also allow a simplified method for calculating the HOD.
Under the simplified method, the taxpayer is not allowed to deduct any actual expenses.
Rather, taxpayers will take the allowable business use square footage and multiply that amount by $5.
The square footage is not to exceed 300 square feet. The maximum deduction under the simplified method will be $1,500.
There are some potential additional limitations on the availability of the HOD for taxpayers that are beyond the scope of this article.
However, I will mention that for the taxpayer to benefit in the current year for the HOD, the taxpayer generally needs to have taxable business income being reported on their tax return.
Unused HOD in a year due to lack of income can be carried forward and used in future years.
The home office deduction can be complicated, and taxpayers need to work with their tax advisors to determine if they qualify for the HOD or not.
This is one deduction that receives a lot of attention from the IRS on an audit basis, so taxpayers should be able to document the exclusive use of the space and how they use the space for business purposes.