When you qualify to take a home office deduction, the business
portion of the following expenses (which are usually not deductible) become deductible:
- utility costs
- home insurance premiums
- the lower of the cost of your home or its fair market value (this is done through depreciation deductions)
A couple of caveats:
- the home office deduction is limited to the income from the business (or job) for which you are using the home office
- home office deductions for employees are only allowed if the employee’s home office is used for the convenience of the employer
- So if your employer provides you with an office at work, but you choose to work at home, you can’t take a home office deduction because you are working at home for your own convenience.
- If your employer does not provide you with an office at work (or the availability of the employer’s office is too restrictive), your home office is more likely to be for the convenience of your employer and be deductible.
Requirements of the Home Office Deduction
A home office must be used REGULARLY and ***EXCLUSIVELY***as:
- your principal place of business
- a place where you meet with customers or clients
- connected with your business if your home office is in a separate structure
If there is any personal use of your home office, it is not being used exclusively for business and the home office deduction is not allowed. There are only two exceptions to the exclusivity rule:
- you are running a daycare out of your home
- the home office is being used to store inventory
If you are running a daycare or using your home office to store inventory, you can take a home office deduction even if the home office is not being used exclusively for business (but the home office deduction is reduced by the percentage that it is being used for personal reasons).
Principal Place of Business Requirement
There are two ways to meet the principal place of business requirement:
- You meet the facts and circumstances test
- the nature of the work performed at each location
- the amount of time you spend at each location is considered.
- You perform managerial or administrative work out of your home office, and you do not perform substantial administrative or managerial work at another fixed location.
Example: Doc is a cardiologist who has a home office where he:
- does billing work
- reads medical journals
- schedules appointments
- does some bookkeeping work for his business
Under the facts and circumstances test, the IRS looks to Doc’s business and the nature of the work he performs at each location. Doc is a cardiologist and performs surgery and consults at hospitals. Since the work of a cardiologist is primarily surgical and consultative, Doc cannot take a home office deduction because his primary work is done at hospitals.
However, Doc can take a home office deduction because he performs managerial and administrative work out of his home office (and doesn’t do such work at other locations).
This fact scenario is based on the Solimon v. Commissioner case. In this case, the Supreme Court agreed with the IRS and disallowed a home office deduction under the facts and circumstances test. Congress responded by changing the law to allow home office deductions for administrative and managerial work done in a home office.
A very important advantage of having your home as your principal place of business is that commuting expenses become deductible. Normally, your commute to your first business stop (and from your last business stop to your home) are nondeductible. When your home is your principal place of business, commuting expenses from your home office to your first business stop (and from your last business stop to your home office) become deductible.
A Place where You Meet with Customers/Clients
You must actually meet with customers/clients at your home (i.e., teleconferencing or videoconferencing does not count). Not much more to say here.
Connected with Your Business if the Home Office is in a Separate Structure
The “connected with” requirement is a much less stringent requirement to meet than the principal place of business requirement. A separate structure can include a detached garage or barn. The reasoning for the less stringent standard is because a separate structure is less likely to be used for personal reasons (e.g., you are more likely to watch TV or have company in your den than you are to watch TV or invite company to your detached garage).
Simplified Home Office Deduction
There is a simplified method of computing the home office deduction. The home office deduction can be calculated by multiplying $5 by the square footage of the home office. The maximum square footage of the home office under this method is 300 square feet, and the maximum home office deduction will therefore be $1,500. Of course, taxpayers still have the option of calculating the home office deduction under the actual expenses method if it results in a larger deduction.
Taxpayers who use the simplified method may still fully deduct mortgage interest, real estate taxes, and casualty losses as itemized deductions. Additionally, businesses expenses such as advertising, wages, and supplies are still deductible. Depreciation may not be claimed.