If you work from home, the IRS might allow you to take a pretty substantial deduction for the business use of your residence. However, the deduction has some specific requirements you need to know about before claiming your home office on this year's taxes. Here's a rundown of this potentially valuable deduction, and what you need to know about the IRS's definition of a "home office."
What is the home office deduction?
If you use part of your home for business, the home office deduction is designed to allow you to deduct the expenses associated with the business usage of your residence.
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There are two ways to calculate the home office deduction -- the simplified and regular methods. Under the simplified method, the deduction is based on the square footage of the home office, rather than the actual expenses associated with the space. As of the 2016 tax year, this option allows for a deduction of $5 per square foot, up to an office size of 300 square feet, so a maximum deduction of $1,500.
On the other hand, the regular method of calculating the home office deduction involves adding up the actual expenses you incurred throughout the year. This includes any money you spent maintaining the office itself (such as repairing the flooring), as well as a proportional share of the entire home's expenses, including but not limited to:
- Mortgage interest
- Rent
- Homeowners' insurance
- Property taxes
- Utilities (electric, water, gas, sewer, garbage)
- Pest control services
- Whole-home repairs (a new roof, for example)
- Depreciation
For example, let's say that you use a 150 square foot room in a 1,500 square foot home as your home office. Since this represents 10% of the square footage of the home, you can deduct this amount of the home's expenses. Here's an example of how this could work:
|
Expense |
Total amount (annual) |
Deductible amount |
|---|---|---|
|
Mortgage interest |
$5,000 |
$500 |
|
Homeowners' insurance |
$1,000 |
$100 |
|
Property taxes |
$2,000 |
$200 |
|
Utilities |
$2,500 |
$250 |
|
Repairs |
$2,500 |
$250 |
|
Depreciation |
$5,000 |
$500 |
In this case, the regular method would result in a deduction of $1,800, far exceeding the $750 to which you would be entitled with the simplified option. So, while the regular option involves a lot more homework on your part, it's worth trying both methods to see which results in the larger deduction.
Two big conditions
The home office deduction can be quite valuable, but the IRS has a specific definition of what qualifies as a home office. In order to qualify, two basic requirements must be met.
First, the part of your home used to calculate the home office deduction must be used regularly and exclusively for business. In other words, the space can't just sometimes be used as your office. For example, if you have an office set up in a room that is also used as a guest bedroom, it's not exclusively used as an office, therefore it wouldn't qualify.
Second, the space must be your principal place of business. This doesn't necessarily mean that you can't conduct business elsewhere -- rather, it simply means that your home office must be a central location of your business activities. A good example is if you're in sales and meet potential customers at their own offices to sell your products, while all of the paperwork involved with your business happens at your home office.
As you can probably imagine, both of these requirements have some grey area. What if you use half of the space in a room exclusively for business, while the other half has some other purpose, like a playroom for your kids? Would you qualify for a deduction? The answer is "it depends."
After all, the requirement says that the office must be "part of your home," not a separate room. It even says in IRS Publication 587, "The space does not need to be marked off by a permanent partition," just that it needs to be "separately identifiable."
The point is that like many other tax topics, the home office deduction isn't subject to a list of set-in-stone requirements, but criteria that are somewhat open to interpretation. Use your best judgement when deciding if you qualify, and consult a tax professional if you're unsure.
Be sure you qualify
As you can probably imagine, the home office deduction is relatively easy to abuse, whether intentionally or not. Because of this, the IRS tends to pay close attention to it -- claiming a home office deduction significantly increases your chances of an audit.
Now, I'm not saying that you shouldn't claim it if you have a legitimate home office. For that matter, you should never let the fear of an audit prevent you from taking every single deduction to which you are entitled. Rather, what I'm saying is that before you claim the deduction, you need to be certain that your home office meets the requirements, and that you can prove it.
