Are you a business owner working from home as a sole proprietor or an entrepreneur with a home-based side gig? You may qualify for sizeable home office deductions if you meet specific requirements, including write-offs attributable to everyday household expenses.
When Tax Opportunity Knocks
To qualify for a home office deduction, you must use at least part of your home regularly and exclusively as either:
- Your principal place of business, or
- A place to meet or deal with customers, clients, or patients in the normal course of business.
In addition, you may be able to claim deductions for maintaining a separate structure, such as a barn or shed, where you store products or tools used solely for business purposes.
Notably, “regular and exclusive” use means you must consistently use a specific identifiable area in your home for business, although incidental or occasional personal use won’t necessarily disqualify you.
When evaluating whether your home office is your “principal place of business,” the IRS could challenge deductions if you work at multiple locations. However, your home office will qualify as your principal place of business if it’s used regularly and exclusively for administrative or management activities. You don’t have any other fixed location for these activities. This may affect taxpayers in various professions and industries, including physicians, architects, interior designers, and plumbers.
How the TCJA Changed Home Office Deductions
Suppose you’ve been working remotely from home during the pandemic as an employee for a company. Previously, people who itemized could have claimed home office deductions as a miscellaneous expense, subject to the 2%-of-AGI rule, if the arrangement was for their employer’s convenience.
But the Tax Cuts and Jobs Act (TCJA) suspends miscellaneous expense deductions for 2018 through 2025. So, employees currently get no personal tax benefit from working from home. On the other hand, self-employed individuals still may qualify if they meet the tax law requirements.
Direct and Indirect Expenses
If you qualify for home office deductions, you can write off the full amount of your direct expenses and a proportionate amount of your indirect expenses based on the percentage of business use of your home.
Indirect expenses include:
- Mortgage interest,
- Property taxes,
- Utilities (such as electric, gas, and water),
- Insurance,
- Repairs and maintenance,
- Home security system fees, and
- Depreciation under IRS tables.
Important: If you itemize deductions, mortgage interest and property taxes may already be deductible. If you claim a portion of these expenses as indirect home office expenses, the remainder will count as a personal itemized deduction.
Calculating Your Deduction
Typically, the percentage of business use is determined by the square footage of your home office. For instance, if you have a 3,000-square-foot home and use a room with 300 square feet as your home office, the applicable percentage is 10%.
For example, say you use a room comprising 10% of your home as an office for your business. You spend $5,000 to have the home office painted and carpeted (direct expenses), and you incur another $10,000 in indirect expenses for the entire home. In this case, you can deduct $6,000 [$5,000 plus (10% of $10,000)].
How to Apply the Simplified Method
Keeping track of indirect expenses is time-consuming and tedious. Some taxpayers prefer to take advantage of a simplified method of deducting home office expenses. Instead of deducting actual expenses, you can claim a deduction equal to $5 per square foot for the area used as a home office, up to a maximum of $1,500 for the year. Although the simplified method takes less time to apply than tracking your actual expenses, it generally results in a significantly lower deduction than writing off actual direct and indirect expenses.
Going back to the previous example of an office comprising 10% of the home, the simplified method would give you a home office deduction of only $1,500. That’s much less than the $6,000 home office deduction you would have received by tracking actual expenses.
Deciding What’s Right for Your Home-Based Business
Do you qualify for a home office deduction? If so, what’s the optimal method for computing your deduction? Contact a Reynolds + Rowella tax advisor to address these and other questions about deducting home office expenses and other self-employed write-offs.
Reynolds + Rowella is a regional accounting and consulting firm known for a team approach to financial problem solving. As Certified Public Accountants, our partners foster a personal touch with our clients. As members of DFK International/USA, an association of accountants and advisors, our professional network is international, yet many of our clients have known us for years through the local communities we serve.
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