The home office deduction is one of the most often misused tax deductions available, and it can get taxpayers in hot water with the IRS. It can be difficult to determine whether or not you can take the home office deduction at all, and taking it requires meticulous record-keeping. To ease this problem, the IRS introduced a simplified home office deduction in 2014. This does make claiming the deduction easier, but may or may not be your best option at tax time.

Who Qualifies for the Home Office Deduction?

Before we get into explaining the methods of calculating your home office deduction, let’s first make sure you qualify for it. To take the deduction, you must meet at least one and sometimes more of the following criteria.

First, your home office must be your primary place of business. If, for example, you make crafts at home and then visit local flea markets to sell them, the IRS could argue that your primary place of business is the flea market since that is where you do your selling. If people come to your house to buy your crafts, however, or if you sell them online, your home will still qualify as your primary place of business. In fact, meeting clients and customers in your home is another qualifying condition for the home office deduction.

Perhaps the most confusing condition, and the one most often overlooked by small business owners, is that you must use the part of your home you deduct for business use ONLY. Let’s say, for instance, that you sell bicycles. You work from home and keep a large inventory of bikes in your garage. Storing bikes is the only thing you use your garage for. In this case, you’re eligible for the home office deduction.

One day, however, you get tired of selling bikes. You close your bike business and start a new home business working as a medical transcriptionist. You turn your spare bedroom into an office and set up your transcription equipment. You do nothing else but work in your new home office. At 5, you shut the door and leave the office until you go back to work. In this case, you’re still eligible for the home office deduction.

Here is where people get confused. What happens if you work on the kitchen table all day, clean up the table at night, and serve the family dinner on the table you used as a “desk” all day? In this case, you are not eligible for the home office deduction as your workplace doesn’t meet the exclusive workplace use test.

Note too that you can only deduct the part of a space you use for work. Let’s go back to our bike-selling example. This time, you have a two-car garage, but you only store bikes in one of the bays. In this case, you can claim a home office deduction for the square footage of one garage but not the other.

And now for one final caveat. To take the deduction, you must be self employed or working at home for your employer’s convenience rather than your own. Again, an example is helpful. If your boss calls you and tells you that they’re having trouble keeping up with COVID sanitation procedures and asks you to work from home, you’re eligible for a home office deduction. If, however, you call your boss and tell him you have COVID concerns and want to work from home, you can’t claim the deduction, even if your boss says yes.

How to Determine Your Home Office Deduction

Under the regular method of calculating your home office deduction, you begin by determining what percentage of your home’s square footage you use as work, inventory storage, or office space. Let’s say it’s 20 percent. You then apply this percentage to all of your home-related bills. In this case, you can deduct 20 percent of your mortgage or rent, mortgage interest, utility bills, maintenance costs, real estate taxes, insurance, and repair bills.

Calculating the deduction in this way isn’t difficult, but it is time-consuming. Unless you’ve been tracking all of this information in one place throughout the year, calculating the deduction at tax time means digging through a lot of paperwork to find the numbers you need.

What is the Simplified Option for Home Office Deduction?

The simplified home office deduction is a bit easier and much faster than calculating the deduction in the traditional way. Under this simplified method, you measure how many square feet of your home you have set aside for business use. You then calculate your deduction by multiplying $5 by the square footage. This number is your deduction. Rather than taking the time to calculate your actual expenses, this method just sets a standard expense rate of $5 per square foot.

Simplified Version vs. Actual Expense Deduction

It’s of paramount importance to understand that the method of calculating your home office deduction does NOT, in any way, alter the rules for who qualifies for the deduction. There are some differences between the standard and simplified methods you need to know, however.

Under the traditional office deduction, there are no limits on the amount of home office space you can deduct. The simplified deduction limits your allowable square footage to 300. When taking the deduction in the old way, you can deduct depreciation costs as part of your expenses. You cannot do so if you use the simplified deduction calculation.

The traditional method also involves more paperwork. To claim the simplified home office deduction, you can simply deduct the amount on your Schedule A when you file your tax return. The traditional calculations require you to list some of your deductions on a Schedule A but report other parts on your Schedule C, if applicable.

Loss carryover is also a factor. Under the traditional rules, if your home office deduction results in a loss, you can carry that loss forward to future years. You lose this option if you opt for the simplified method.

Selecting a Method

Simplified Version vs. Actual Expense Deduction

It’s entirely up to you whether you choose to use the traditional home office expense calculation or the simplified version. The simplified version is much faster, but it’s not always the most beneficial.

If your home business takes up a large amount of space in your home, the simplified version may reduce the amount of your deduction. This is generally the case if your business involves more than 300 square feet of your home. You may also benefit from the traditional deduction calculation if you had an expensive year. A big-ticket purchase for your home, such as a new roof or a kitchen renovation, can increase the amount you spent on maintaining the home. As such, using your actual expenses may net you a larger deduction than the simplified calculation of $5 per square foot.

Making your selection between the two deduction calculation methods requires no special paperwork or declarations. Simply file your taxes according to the rules for whichever method you choose and the IRS will understand your choice. Remember that you can change your mind from one year to the next.

IRS Form 8829

If you opt for the simplified home office deduction calculation, you will report the information on your Schedule A as noted above. If you choose the traditional method and file a Schedule C, the IRS also requires you to file a form 8829. This form breaks down your home office deduction into its parts so you can detail your calculations as you work through them. This form will also calculate how much of the deduction is a personal deduction and how much is a business expense.

A Word of Encouragement and a Warning

There are two very important things left to say about the home office deduction. One is
to offer encouragement. If you’re eligible for the home office discount, don’t shy away from taking it. Sometimes eligible taxpayers skip it because they know how many other taxpayers get tripped up when they take it erroneously. If you’re worried about this as well, talk to a CPA at Picnic Tax for help. Don’t short yourself over audit anxiety when we can easily help you take the deduction properly.

Unfortunately, our next message is a bit more ominous. In some instances, taking the home office deduction under the traditional method can cause a problem later on. Generally, taxpayers who meet certain criteria when selling their primary residence can avoid paying capital gains tax on the first $250,000 of income ($500,000 if married filing jointly). Taking the home deduction using the traditional calculation may cause you to lose this ability in some circumstances. Talking to a CPA to see if this applies to you is critical.

As you can see, even simplified tax strategies come with rules and conditions that can make them a bit confusing. The home office deduction is a helpful tool, however, and one worth utilizing if and when you can. Reach out to the tax professionals at Picnic Tax today and we’ll help you decide which deduction calculation method will work best for you and your financial goals.