Can I Claim Deductions For a Home Office?

If I’m working from home, can I claim a deduction for a home office?

Our traditional working environment is changing with more people working from home, in a hybrid work arrangement or working fully remote from home. So, when can a taxpayer claim a deduction for a home office – and what expenses will qualify? (Military personnel follow different rules, and is not covered in this article)

If you are an employee, working for a company that provides you with a W-2 form at year-end, then the IRS has, as of recently, disallowed a home office deduction for you (since the passing of the Tax Cut & Jobs Act in 2017, and effective thru year 2025).

As a self-employed business owner, you’ll want to look at the tax benefits of a home office deduction.

The home or dwelling unit that you use for your home office must be one of the following:

• The principal place of business;
  • The central or base location of where important business matters occur
• A place to meet patients, clients, or customers in the normal course of business;
  • Can be deducted even if there is another principal place of business
  • Must be substantial & integral to the business (not occasional meetings)
• A separate structure not attached to the dwelling – and used in connection with the business; or
• If the dwelling is the only fixed location of the taxpayer’s business, a space within it that is used regularly to store the business’s inventory or product samples.

In all cases, the IRS uses 2 specific words to test for home office use … regularly & exclusively used to conduct business. A kitchen table or living room coffee table generally would not qualify, even if you conduct business there every day, because the area is not exclusive for work. But a completely isolated area is not necessary either. The work area needs to be a separately identifiable space. There have been instances where the IRS has disallowed a home office deduction because there were toys or exercise equipment in the “exclusive use” zone, which disqualified the space. In regards to the regular use requirement, the occasional or incidental use of a home office will not qualify.

• Note: there are 2 situations that exclusive use is not required:
  • Day care facility
  • Storage of inventory or product samples, if there is no other business location

There are 2 options for calculating the home office deduction: (1) actual-expense method, or (2) simplified method.

Option (1): Actual expense method include both direct and indirect costs.

An example of a direct cost is flooring installed in the office area and is fully deductible. Indirect costs are allocated proportionately between business & personal use, using a reasonable method. Indirect costs include:

• If you own your home … real estate taxes, mortgage interest, depreciation
• If you rent … rent paid
• Utilities
• Insurance
• Repairs & maintenance
  
  

Option (2): Simplified method is a safe harbor provided by the IRS allowing the taxpayer to use $5 per square foot for the portion used for business, up to a maximum of 300 square feet (results in a maximum deduction of $1,500).

This method avoids the tracking of actual expenses or complex calculations.

One of the down sides to the actual-expense method is the potential depreciation recapture that would be required if the dwelling is sold in a later year, requiring the recognition of taxable income in that year of sale. The simplified method does not have the depreciation recapture issue, which some taxpayers prefer.

Some other brief notes on the home office deduction:

1. A home office deduction is limited to the net income of the business.
2. If a deduction cannot be claimed in that year due to the income limitation, the deduction can be carried over to the next year, if using the actual expense method. (no carryover for the simplified method)
3. A taxpayer can alternate methods (actual vs simplified) from one year to another.

A partner in a partnership can deduct home office expenses on their individual tax return as follows:

• The partner is expected to pay these expenses without reimbursement, and
• The partnership agreement expressly states that the partner is required to pay the expenses personally, and
• The partner maintains adequate support documentation of the expenses.

Unlike the sole proprietor’s income limitation referred to above, a partner can deduct the unreimbursed partner expenses (UPE) if in excess of the income from the partnership K-1.

For an S-corporation, a shareholder-employee that has unreimbursed home office expenses, these would fall under the disallowed “employee” business expenses. S-corporation business owners should establish an accountable plan, where the company reimburses the shareholder-employee for the home office expenses, which includes documentation substantiation.

Do you have questions about home office deductions? We’d love to chat with you! You can make an appointment to speak to a tax professional at any of our 5 locations.