The home office deduction is a great way for small businesses to write-off one of their largest personal expenses: housing.
Tax deductions that don’t require you to spend any extra money are my favorite. In fact, that’s how the home office deduction landed on my “best of” list.
Between the pandemic and the proliferation of the gig economy, many Americans have found themselves working from home.
This has led to many questions about the home office deduction. What is it? Who can claim it? How is it calculated?
In this article, we’ll get to the bottom of it.
What Is The Home Office Deduction?
The home office deduction is a way for business owners to recover the cost of the business-use portion of their housing expenses.
I know, that’s a mouthful. Let’s break it down.
The best way to think about it is to imagine that you and your business are two separate beings.
I remember one of my college professors conceptualizing this separation by asking us to imagine that our business was our pet robot. I know—weird—but it got the point across:
Me. My business. Separate.
Obviously you use your home and you pay rent (or a mortgage). But guess who else uses your home? That’s right—your robot. Shouldn’t he pay rent too?
That’s what the home office deduction is. Robot rent.
Do I Qualify for the Home Office Deduction?
Let’s start with who doesn’t qualify: W-2 employees. If you are employed as a w-2 earner, you do not get to claim the home office deduction under any circumstance.
The Tax Cuts and Jobs Act of 2017 completely eliminated the ability for employees to deduct the unreimbursed expenses associated with their work.
In order to qualify, you must report income on Schedule C of your personal tax return.
Other business entity types may be able to deduct their home office expenses as well but I will discuss that in another article.
Schedule C is where you report your non-employee compensation. You likely have non-employee compensation if you’re a freelancer, side hustler, small business owner, you receive any 1099-NEC forms, or you’re the only member of an LLC.
Even if you file a Schedule C, you’re not in the clear just yet. Having non-employee compensation is only the first hurdle in qualifying to deduct your home office expenses.
Principal Place of Business
In order to claim the home office deduction, the home office must be your principal place of business. That’s a fancy way to say that you can’t claim the home office expense if you rent an office outside of your home.
If you do rent an office outside of your home, you can deduct the rent for your office but you lose the ability to “double dip” on your personal housing expenses.
Exclusive and Regular Use
If your home office is your principal place of business, you also need to meet the exclusive and regular use test.
Your home office must be used exclusively for business. That means you can’t set up shop at kitchen table and call the whole dining area your office.
You can’t do anything except work on your business in your home office area.
You also need to use the space regularly. If you just pop in every couple of weeks, that doesn’t fly.
Contrary to popular belief, your home office doesn’t need to be a dedicated room—just a dedicated space.
So, you can dedicate the corner of your bedroom as your home office. Just be sure to identify the square footage of your home office area and only perform work activities in that area.
As ridiculous as it may sound, I recommend that you grab some painter’s tape and mark off where your home office begins and ends.
Take a picture and keep it in your tax file. This will also help you accurately measure the square footage of your home office space.
How to Calculate the Home Office Deduction
Home office expenses are calculated on IRS Form 8829. There are two different ways you can calculate your home office deduction.
The first way is called the regular method.
To start, you’ll calculate your business-use percentage by dividing the square footage of your home office by the total square footage of your entire home.
Using the regular method, you will deduct the business use percentage of your housing expenses. Eligible expenses include: rent, mortgage interest, insurance, utilities, repairs, and maintenance.
The regular method tends to favor those that rent. If you own your home, you will be required to depreciate your home for tax purposes.
Not only is difficult to calculate depreciation properly on your own, it can also interfere with the IRC § 121 gain exclusion if you ever decide to sell your home.
Homeowners may want to opt for the simplified method, even if it’s a smaller deduction than using the regular method.
The simplified method is, well, simpler. Under the simplified method, the IRS allows a home office deduction of $5 per square foot of your home office space (up to 300 sq. ft. or $1,500).
So, if your home office is 100 square feet, your home office deduction is $500 ($5 x 100 sq. ft.) using the simplified method.
If your home office is 400 square feet, the IRS will still only allow up to $1,500.
Home Office Takeaways
To wrap up, let’s recap the key points for claiming the home office deduction:
- W-2 employees do not qualify
- You must have Schedule C Income to qualify
- If you rent an office outside of your home, you do not qualify
- Your home office must be your principal place of business
- You must use your home office regularly
- Your home office is off limits to any activities other than business
- There are two ways to calculate your home office deduction
- The larger deduction of the two methods might not be the best one for your situation!
The home office deduction is a fantastic tax saving tool for small businesses. By establishing your home as your principal place of business you can unlock one of the most useful tax deductions available.
How are you taking advantage of the home office deduction for your small business?