In recent months, more people are working for home (primarily due to the novel coronavirus). A recent Gartner survey of CFO's noted that 82% expect to let employees work remotely some of the time and 47% expect to let employees work remotely all of the time (Gartner, July 14, 2020). With this growth in working from home, the interest in the home office deduction has increased. We take a look at the rules, and if you are an employee, they are not in your favor.
The home office deduction is claimed on Form 8829, and it may be helpful to have the form available while review the post.
Home office Deductions for Employees
The Tax Cuts and Jobs Act signed in 2017 suspended miscellaneous itemized deductions of which a large portion of these deductions were related to employee work expenses. As such, as an employee, you are not allowed a home office deduction. There has been some talk about Congress revisiting this issue, but it does not appear to be in the works any time soon.
Home Office Deduction for the Self-Employed
The home office deduction for the self-employed is still available, and with the growth in the number of independent contractors and solo professionals, a substantial number of them may qualify for the home office deduction.
Requirements to qualify for the home office deduction
- There must be exclusive use of a portion of the home for conducting business on a regular basis. For example, a taxpayer who uses an extra room to run their business can take a home office deduction only for that extra room so long as it is used both regularly and exclusively in the business.
- The home must be the taxpayer's principal place of business. A taxpayer can also meet this requirement if administrative or management activities are conducted at the home and there is no other location to perform these duties. Therefore, someone who conducts business outside of their home but also uses their home to conduct business may still qualify for a home office deduction.
Exclusive Use Test
The most difficult rule to meet is the exclusive use test. Exclusive use generally means 100% of the use of the office is for business. This is the standard that we generally recommend our clients meet. However, a 2014 tax case applied some reasonableness standard to the exclusive use.
In Miller v. Commissioner (TC Summary Opinion 2014-74 (2014)) the taxpayer rented about a 740 square foot apartment in New York City. The taxpayer claimed the home office deduction and her return was audited and the case went to Tax Court. It seems the deduction was denied because she had to walk through her home office to get to the bedroom. The court determined that some reasonable standard would not disallow the deduction simply because she had to walk through the home office.
I don't think we can apply this same standard to a home office that is also used as a guest bedroom, game room, or play room. It is best to structure the home office as used exclusively for business use.
Regular Use Test
The regular use test should generally not be a problem for a legitimate home office deduction. Regular use implies substantial use, but not constant use.
Example: Sara is a self-employed insurance agent who spends most of her day on the road meeting with clients or potential clients for life and disability insurance. She returns each day and uses her home office to make notes of her conversations, prepare quotes and presentations, and complete applications. She has no other office from which to complete these activities. Sara clearly meets the regular use requirement.
What is a home
- Includes a house, apartment, condominium, mobile home, boat or similar property
- Also includes structures on the property. These are places like an unattached garage, studio, barn or greenhouse
- Does not include any part of the house used as a motel, inn (Airbnb).
Expenses that relate to a separate structure not attached to the home will qualify for a home office deduction. It will qualify only if the structure is used exclusively and regularly for business.
Calculating the Deduction
The simplified method is ideal for those who do not want to track all the related expenses discussed later under the regular method. With the simplified method, you are allowed a $5 per square foot deduction up to a maximum square footage allowed of 300 sq ft. So, the deduction under the simplified method is capped at $1,500.
The regular method will often provide a greater deduction, but will require more recordkeeping to sustain the deduction. The first step in computing the deduction is determine the square footage of the home office and the square footage of the house.
The above determines the percent of deductible expenses. For example, if the office square footage is 180 square feet and the house is 1,800 square feet, then then ten percent of the deductions are allowed (180/1800).
You will need to determine the following expenses: mortgage interest, real estate taxes, insurance, rent (if you rent the home/apartment), repairs, utilities, security system costs, and any other expenses.
Most of the expenses above are indirect expenses (this means they are allowed to the extent of the business use of the home (in the example above, 10%).
Direct expenses are those expenses incurred directly to the home office.
Example: In your home office, you had to install an extra electrical outlet, an internet cable, and some additional lighting. These items are considered direct expenses since they were incurred specifically in the home office. You may deduct these expenses in full for your home office.
You may switch back and forth between the regular method and the simplified method. We recommend using the one that provides the greater deduction each year.
Finally, the home office deduction may not create a loss for the year. However, if you use the regular method, you may carryover the unused amount of the home office deduction to the next year. You are not allowed a carryover of the simplified method to succeeding tax years.
We hope this summary helps, reach out to us on Facebook or call our office if you would like to see how the home office deduction would benefit your personal tax situation.
Our office is in Lubbock, Texas, but we serve clients throughout the state of Texas. Join the conversation on Facebook @bradleysmithinc