Make the Most of Home Office Deductions
Home offices may be the most misunderstood deduction available.
Taxpayers fear they raise audit flags. But home offices can save thousands in tax. And it’s easier than ever to qualify. Your home office qualifies if you meet one of these three tests1:
- It’s your “principal place of business,”
- You use it to meet clients, patients, or prospects in the normal course of your trade or business, or
- It’s a separate structure not attached to your dwelling unit.
Your home office qualifies as your principal place of business if: 1) you use it “exclusively and regularly for administrative or management activities of your trade or business”; and 2) “you have no other fixed location where you conduct substantial administrative or management activities of your trade or business.”2 This is true even if you have another office, so long as you don’t use it more than occasionally for administrative or management activities.
You have to use your office regularly and exclusively for business. “Regularly” generally means 10-12 hours per week.3 To prove your deduction, keep a log and take photos to record your business use. You can claim a workshop, studio, or “separately identifiable” space you use to store products or samples. The space doesn’t have to be an entire room. If you use it for more than one business, both have to qualify to take the deduction.
To calculate your deduction:
- Determine business use percentage (“BUP”) of your home. You can divide by the number of rooms if they’re roughly equal, or calculate the exact percentage of square footage. Exclude common areas like halls and stairs to boost BUP.4
- Deduct BUP of rent, mortgage interest, and property taxes.
- Depreciate the BUP of your home’s basis (excluding land) over 39 years as nonresidential property.
- Deduct BUP of utilities, repairs, insurance, garbage pickup, and security. If BUP for specific expenses differs from BUP for the home (such as high electric bills for home office equipment), claim the difference as “direct” expenses.”5
You can use home office expenses to shelter profits, but not below zero. If home office expenses exceed your net business income, carry forward excess losses to future years.
When you sell your home, you’ll have to report any depreciation you claimed or could have claimed after May 6, 1997 as “unrecaptured Section 1250 gain.” You can still claim the $500,000 tax-free exclusion for home office space unless it’s a “separate dwelling unit.”6
If you’re taxed as a proprietor, report home office expenses on Form 8829. If you’re taxed as a partnership or S corporation, report them on Form 1065 or Form 1120S. (This makes home offices even less likely to attract IRS attention.) If you’re taxed as an employee, report home office expenses on Form 2106. Report unrecaptured Section 1250 gain when you sell your home on Form 4797.
- IRS Publication 587: Business Use of Your Home
- IRS Publication 544: Sales and Other Dispositions of Property
- Claiming a home office as your principal place of business eliminates commuting miles and boosts deductible business miles.
- Code section 280A(g) lets you rent your home tax-free for up to 14 days. Consider renting your entire home to your business for meetings, entertainment, or similar purposes to deduct money from your business without owing tax on it personally.
- Starting in 2013, you can use a “safe harbor” method to deduct $5 per square foot, for up to 300 feet of qualifying office space. You’ll continue to deduct your mortgage interest and property tax on Schedule A. However, you’ll forego any depreciation deduction. And if the safe harbor deduction reduces your business income below zero, there’s no carrying forward the loss. However, the simplified accounting makes it an attractive option.
If you claim home office deductions for space you use as an employee, you have to show that your employer requires you to maintain the office for the employer’s convenience.
IRS Pub. 587 (2003).
Green v. Comm’r, 78 TC 428 (1982).
IRS Publication 587.
Form 8829, Instructions, p. 2 (2008).
Rev. Rul. 99-7.
Rev. Proc. 2013-13. IRC §280A(c)(1).