If you're eligible, a home office deduction can save you big bucks at tax time. If you're not, claiming it can get you in big trouble.
By now, you should have received paperwork documenting your 2016 income, as well as paperwork from those who paid you interest and from those you paid. You’ve also corralled your receipts to document your deductions, right?
But before you sit down to take care of business, make sure you understand one key way to reduce your tax bill: the home office deduction. According to the IRS, “In tax year 2012, the most recent year for which figures are available, nearly 3.4 million taxpayers claimed deductions of more than $10 billion for business use of a home.”
Want to be one of them this Tax Day? Here’s what you need to know.
1. Eligibility: Is it exclusive space?
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A home office deduction is a great way to make normally nondeductible expenses like rent and utilities partially deductible. But simply doing some work at the dining room table isn’t enough to qualify. You need to be using part of your home as your principal place of business, and using it exclusively for that purpose.
IRS Publication 587 says, “To qualify to deduct expenses for business use of your home, you must use part of your home … exclusively and regularly as your principal place of business.” That sounds straightforward, but it’s less so than it seems. For example, when they say “exclusively,” here’s how that works.
- The space can be as small as a desk or as big as a room. There’s no size requirement, and there don’t have to be walls or partitions marking it off. It just has to be a “separately identifiable space” and used exclusively for business.
- The space you want to deduct expenses for can’t be used for personal purposes. The couch you watch TV on doesn’t count. And even if you do all of your accounting in the dining room, eating there nixes the deduction.
- You can ignore the previous point if the business use is “storage” or “day care,” but then there is an entirely different set of requirements you have to meet. Storage space has to be for product inventory you intend to sell, and your home has to be “the only fixed location” of your business. So you don’t qualify if you’re just storing extra business equipment, or operate in a commercial space and keep spare stock at home. Homes used for day care businesses have to meet and maintain state licensing requirements.
- Like independent contractors or sole proprietors, employees can deduct home office expenses, but there are additional restrictions. Your use has to be for the company’s convenience (because they lack space, for instance) instead of yours (it’s easier to work from home). You also can’t double-dip by renting the space to your employer and claiming the deduction.
2. Is it the ‘principal place’?
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The other major tricky term is “principal.” Here’s what the IRS means by that:
- It’s OK to have more than one place of business and claim the deduction. But you can only claim the home office if it’s where you do the majority of the work, or certain kinds of work.
- If your home office isn’t where you spend the most time or do the most important part of your job, it’s still a valid deduction if you use it “exclusively and regularly for administrative or management activities” such as billing, record keeping, ordering, writing reports or booking appointments. So, people like plumbers, whose job is to visit other people’s homes and businesses for a living, potentially can still claim the deduction.
- There are several situations that don’t automatically disqualify your home office, including: having somebody else handle the administrative stuff, handling those kinds of tasks minimally outside the office or while traveling (“places that are not fixed locations of your business”), or primarily using your home office for administrative tasks even though another place in your business has ample space for them.
- Another big exception for doctors, dentists, attorneys and many other professionals: If part of your home is used exclusively and regularly to meet with clients, patients or customers, it still qualifies for the deduction without being your primary place of business. But telephone calls and occasional visits don’t count; you have to meet in person, regularly.
- It’s OK to take a partial deduction if you met the requirements for only part of the year. Just make sure you get the math straight.
3. Figuring the deduction
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Before you begin, you’ll need to know the total square footage of your office space and home, because you’ll be deducting the percentage of home-related expenses the business uses. So if you have a 2,000-square-foot home and use a 200-square-foot spare bedroom as a home office, you’ll deduct up to 10 percent of the rent or mortgage payments, utilities, insurance and so on. Stuff that’s only for the business area, like paint, can also be fully deducted.
4. A new, simpler way to claim it
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Starting with tax year 2013, the IRS introduced a simpler way to compute the deduction. It allows those with qualifying home offices to deduct up to $1,500 nearly hassle-free. (According to the IRS, this will collectively save filers 1.6 million hours of work annually.)
Rather than adding up the proper percentage of rent, electricity and other home office expenses, all you do is deduct $5 per square foot of your home office. The only drawback: The new method is capped at 300 square feet, limiting the deduction to $1,500 per year.
So if the portion of your home used for business is larger than 300 square feet, and/or the deduction would add up to more than $1,500, you’ll want to use the old method. If not, keep it simple by using the new one.
5. Don’t be shy, but do be careful
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Because home offices are ever more ubiquitous and the potential deduction so attractive, you can imagine this is something many taxpayers might be tempted to abuse. After all, the IRS gets a copy of your W-2 from your employer, but they probably don’t yet know the square footage of your former guest bedroom.
But be careful. The same factors that make this deduction easy to fudge also make it one that invites scrutiny. This doesn’t mean you should be afraid to take it. Always take every deduction you’re legally entitled to. But when it comes to this one, make sure you can verify it, just in case.
Do you have experience claiming your home office as a deduction? Share with us in comments below or on our Facebook page.