Does the thought of taking the home office tax deduction cause you anxiety? You’re not alone.
The home office deduction used to be associated with something everyone wants to avoid – an IRS audit. This caused many people to avoid taking the deduction even if they could legitimately claim it.
Fortunately, simplified rules in recent years have made the deduction easier to take. Is it so simple to calculate that self-filers can take it? It depends on the method you use and the costs you factor in. Many filers outsource their taxes so they can concentrate on doing what they do best. If you do decide to do it yourself, make sure to get educated on proper bookkeeping techniques and filing requirements.
Does Your Home Office Qualify?
Freelancers, entrepreneurs and even W2 employees who work from home can generate significant tax savings by taking the home office deduction. If you’re reading this, chance are you are someone who could benefit from this deduction, so here is what you need to know to take it.
If your “home office” is really a desk in the corner of your kids’ play room it doesn’t qualify you for this deduction. Same thing if your office is located in your living room, kitchen counter, or guest bedroom.
In order for your office to satisfy IRS requirements it has to be only used as an office. That means there cannot be any other activities that take place in your home office that wouldn’t take place in a commercial office environment. So splitting a room between crafting and work is going to disqualify you, unless crafting happens to be your business.
Your home office also must be the place where you meet with customers or be the primary place where you manage your business. If you work out of an office but do occasional work at home the deduction does not apply to you. And, the address of your home office should be listed with all relevant authorities as the business address.
If you are ever audited and the IRS determines you’ve claimed the home office deduction illegitimately, the auditor can then look back at prior year returns for other examples of this infraction and other discrepancies. Anyone who decides to bend the rules for claiming the home office deduction must decide if this lookback possibility is worth the risk.
Calculating the Deduction
If the home office tax deduction applies to you there are two options for calculating it. How do you choose which route to take? Come tax season, simply calculate both deductions to see which one benefits you the most.
- Percentage of Home. To use this method you need to know the total square footage of your home and the square footage of your home office. Once you have both of these numbers you simply calculate the percentage of your home used for your home office, then apply this percentage to your qualifying expenses for the year. For example, if your home and office are 2,000 and 200 square feet respectively, your office is 10% of your home.
- Simplified Rate Per Square Foot. In 2013, the IRS created a simplified calculation in an effort to make things easier. They established a set rate you multiply by a maximum square footage. In 2017 the figures are $5 per square foot up to a maximum of 300 square feet, or $1,500 per year. As these figures are subject to change, check with the IRS to make sure you have the correct ones for the tax year in question.
What Expenses Qualify?
When calculating the percentage of home method, here are the expenses that qualify:
- Maintenance and repair expenses – Homes need maintenance and your home office is no different. Repairing a broken office windowpane or patching a hole in an office wall would be included here in their entirety. If you painted your entire house, you could apply the percentage calculation to that cost and include it in your deduction.
- Improvements – These are treated a little differently. If you replace the roof or install a security system, these costs can’t be deducted all in one tax year, but can be prorated for the space and depreciated over several years.
- Utilities and other home expenses – You can apply your deduction percentage to your gas, electric, water and waste bills, and even to house cleaning costs.
- Mortgage, insurance and property tax costs
- If you rent your home you can claim the calculated percentage of your rent.
- If you own your home you have the option to depreciate the value of the home office space as prescribed by the IRS. Before including this in your deduction you should know that if you sell your house at a profit you will owe capital gains tax on your accumulated depreciation. Since real estate values typically increase the longer you own your home, many home office workers skip depreciation.
With all of the possible expenses that can qualify for the percentage of home option, many tax filers choose to use this method. If you do, it’s important to keep good records of your expenses.
The many direct and indirect expenses you incur working at home can create a powerful and legitimate tax benefit. Don’t miss out on this opportunity to keep more of your hard earned money.
For more information on the home office deduction read the IRS’s guidance on business use of your home.