Home Office Tax Deductions: Maximizing Your Savings

Image - tax.svg

If you're reading this, chances are you've heard the old saying: "You should take a deduction where you can get one." Okay, so maybe that exact saying doesn't exist (yet), but let's face it, finding every possible tax deduction you’re entitled to is an invaluable exercise; every deduction makes a difference.

So, if you are one of the growing number of people who have transformed their homes (or even a small part of them) into an office space, you’re in luck! Why? Because there’s a good chance that you can claim tax deductions on some of those home office expenses.

Read on to see who can claim a home office tax deduction, what the surrounding rules are, and how much you can claim as a home office deduction.

What Is a Home Office Tax Deduction?

Simply put, a tax deduction is an amount that you can deduct from your taxable income, thereby reducing the taxes you are liable to pay.

The home office deduction allows qualified taxpayers (more on that in a bit) to deduct certain home office expenses, e.g., rent, utilities, repairs, etc., from their taxable income when they file taxes.

What Qualifies as a “Home” as per the Rules?

Before we get into the question of your eligibility to claim a home office tax deduction, it’s important that we clarify what the IRS defines as a “home” for this purpose. If your house has wheels, would that qualify? What if you’re living/working on a boat? What then?

When it comes to this deduction, the definition of "home" includes various types of properties:

  • Houses, apartments, and condominiums
  • Mobile homes (so, yes to a house on wheels)
  • Even boats or similar accommodations
  • Structures located on the property:
    • Unattached garages
    • Studios
    • Barns
    • Greenhouses, etc.
What isn’t included under this definition?

Well, any part of your property that you use exclusively for commercial purposes, like a hotel, motel, inn, or similar business, does not qualify for this deduction.

It’s also important to note that you can claim a home office deduction whether you’re a homeowner or you’re renting the place.

Who Can Claim This Deduction?

By now, we are all too familiar with the home office situation - every nook a potential workspace, every trusty pajama set acceptable workwear. But when it comes to home office deductions, there is a catch: not all people working from home qualify.

To give you some context, the Tax Cuts and Jobs Act passed in 2017, among other things, eliminated home office deductions for individual taxpayers working as employees. Therefore, employees are not allowed to claim this deduction.

As the law stands now, home office deductions can be claimed by self-employed people, entrepreneurs, independent contractors, small business owners, etc., provided that their home offices meet the required criteria (which we will dive right into next).

But what if you have a freelance gig on the side while working a full-time job? What if you were self-employed for a few months? So long as the other criteria with regard to home offices (its use, etc.) are met, those with freelance side jobs (even if they are employed) or individuals who were self-employed for a limited period can claim this deduction.

For example, if you did some freelance work for a few months while searching for a full-time job, you can claim the home office deduction for the duration of your self-employment and remote work from your home office. However, to be eligible for the deduction, you must have some self-employment income reported on Schedule C.

Which Expenses Can I Deduct?

You can deduct the following expenses:

  • Real estate taxes
  • Mortgage interest
  • Rent
  • Casualty losses
  • Utilities
  • Insurance
  • Depreciation
  • Maintenance
  • Repairs, etc.

Home Office Deduction: Qualifications

Let’s say your home fits the criteria we discussed, you’re self-employed, and you use a part of your house as an office space. You’re probably sitting at your desk at home right now wondering whether you automatically qualify to claim this deduction.

Well, it really depends. There are certain rules not just about what space you use as your home office but also how you use this space. For instance, if you have a room that you use as an office but also a bedroom (cue: pandemic flashbacks), does this count as a home office?

To qualify for a home office deduction, your home office must satisfy certain conditions:

  • Exclusive use
  • Regular use
  • Use for trade or business
  • Principal place of business

Exclusive use

To meet the exclusive-use test, you must dedicate a specific area in your home exclusively to your business activities. This area can be a room or any identifiable space. This does not mean that you need to permanently cordon off this area specifically or that any physical partition is required. All it means is that you must use this space for business purposes only.

Therefore, if you use the same area for both business and personal purposes, you won't meet the exclusive-use requirement. For example, let's say you run a photography business and use a spare bedroom in your home as your studio. If your family also uses the room for other activities (say, your children use the room as a playroom), it fails the exclusive-use test, and you won't be eligible for a deduction for that space.

There are some exceptions to this rule though.

  1. If you use a specific part of your home to store inventory or product samples

If you use some part of your home to store inventory or product samples, you can claim a home office deduction even if you don't meet the exclusive-use test. However, you must meet the following criteria:

  • Your trade or business involves selling products at wholesale or retail.
  • You keep the inventory or product samples in your home for use in your trade or business.
  • Your home is the sole fixed location of your trade or business.
  • You use the storage space regularly.
  • The space you use for storage is a separate and identifiable area suitable for that purpose.

For example, imagine you operate a business selling artisanal pottery at retail, and your home serves as the only fixed location for your business activities.

Within your house, you have set aside half of your basement for storing inventory and product samples. While you sometimes use this space to undertake personal projects or store personal items, you can still deduct the expenses related to the storage area.

This exception allows you to claim the deduction for the business use of the storage space, even though it is not exclusively dedicated to business purposes.

  1. If you use that part of your home as a daycare facility

If you regularly use a part of your home to provide daycare services, you may qualify for a deduction for that specific area, even if you utilize it for personal purposes. To qualify for this exception to the exclusive-use rule, you must meet the following criteria:

  • You are engaged in the trade/business of providing daycare for:

    • Children
    • Individuals who are 65 years or older
    • Individuals who are physically or mentally unable to care for themselves
  • You must have applied for, received, or be exempt from obtaining a license, certification, registration, or approval as a daycare center or a family/group daycare home as required by state law.

    If your application was rejected or your license/authorization was revoked, you do not meet this requirement.

Regular use

To meet the regular-use test, you must use your home office space (as described in the previous section) regularly and consistently. Infrequent or sporadic use does not satisfy the requirement of regular use. To see if you meet this test, you need to consider the overall pattern and frequency of your business-related activities in your home office space.

Let’s say there’s a room in your house that is usually unoccupied. You use it occasionally for purposes largely insignificant to your business. In such a case, you do not qualify. On the other hand, if you work in your home office for a few hours every day, you may meet the requirements.

The determination of whether this test is satisfied depends on the specific details and circumstances of each case as evaluated by the IRS.

Use for trade or business

To satisfy this requirement, you need to use your home office for a trade or business. Undertaking just any sort of profit-making activity doesn’t make the cut; the activity must be considered a trade or business. For instance, if you use a specific area of your home solely for managing your investments, which doesn't qualify as a business, you won't be eligible for a home office deduction.

Principal place of business

This test requires that your home office be your principal place of business, even if you run your trade or business out of multiple locations. To determine whether your home office qualifies, consider the importance of activities you perform in each of these locations and the time you spend there.

Your home office will qualify if you use it exclusively and regularly to carry out administrative/management activities related to your trade or business, i.e., you have no other fixed location where you conduct substantial administrative/management activities.

What are administrative/management activities?

Administrative or managerial tasks encompass various activities. Here are a few instances:

  • Handling financial transactions (e.g., billing) with customers, clients, or patients
  • Maintaining financial records and documentation
  • Ordering necessary supplies
  • Scheduling appointments
  • Transmitting orders or writing reports

As long as you use your home office for substantial managerial and administrative tasks, the following actions will not disqualify you from claiming the deduction:

  • Having others perform some of your administrative or management activities at locations other than your home (e.g., outsourcing your billing to another company)
  • Conducting administrative or management activities in places that are not fixed business locations (e.g., a car or hotel room)
  • Occasionally carrying out minimal administrative or management tasks at a fixed location outside your home
  • Engaging in substantial non-administrative or non-management business activities at a fixed location outside your home, such as meeting clients or providing services
  • Having suitable space elsewhere for administrative or management activities but choosing to use your home office instead

Exception: Meeting patients, clients, or customers

If you regularly meet or interact with patients, clients, or customers in your home office (used exclusively for business purposes) in the normal course of your business, even if you also conduct business elsewhere, you can claim the home office deduction if:

  • You have face-to-face meetings with patients, clients, or customers there.
  • Their utilization of your home is significant and essential for conducting your business.

The part of your home you use for this purpose does not need to be your principal place of business.

What Are the Rules Regarding Separate Structures?

If you use a free-standing structure like a garage, barn, greenhouse, etc. on your property regularly and exclusively for your business/trade, you can claim a deduction on the associated expenses even if:

  • It is not your principal place of business.
  • It is not a place where you meet your patients, clients, or customers.

How Can I Calculate the Deduction?

You can calculate the deduction using one of two methods: the standard method or the simplified method. The simplified method is easier to use but may result in a smaller tax benefit. The standard method, on the other hand, requires more complex calculations and record-keeping but has the potential to provide a larger deduction. Ideally, by calculating your deduction using both methods, you can check which method yields a higher deduction.

Simplified method

Under this method, you can claim a deduction of $5 (the prescribed rate) per square foot of your home office space (up to 300 square feet), which comes up to a maximum deduction of $1,500. If your home office meets the necessary criteria, you can claim this tax deduction without the requirement of tracking individual expenses.

Standard method

When you utilize the standard approach, deductions for a home office are calculated by considering the proportion of the residence dedicated to business purposes.

Also, you must determine the direct home office expenses, which you can deduct in full, and the indirect expenses, which you can deduct based on how much of your home you use as your home office.

Expense Description Deductibility
Direct Expenses directly related to your home office (office repairs, etc.) Fully deductible (subject to the deduction limit*)
Indirect Expenses related to your entire home (gas, electricity, water, etc.) Deductible based on the percentage of space you use for your home office
Unrelated Expenses unrelated to the parts of your home used for business (lawn upkeep, etc.) Not deductible

Suppose you incurred the following direct expenses on your home office:

  • Fixing a leak and painting your home office: $750

And the following indirect expenses:

  • Mortgage interest: $3,000
  • Utilities: $4,000

Now, let’s say your house is a total of 2,500 square feet, of which your office takes up 450 square feet.

Divide the area of your office by the total area of your house (450 ÷ 2500 = 0.18, which is 18%). This is the percentage of indirect expenses (expenses you incurred on your home) you can claim as a deduction. Your direct expenses ($750) can be deducted in full.

Therefore, you can deduct $1,260 (18% of $7,000) plus $750, which is a total of $2,010.

*Deduction limit: When the expenses you incur are lower than the gross income generated from your home-based business, you can deduct all of your expenses. But if your expenses surpass your gross income, only a portion of the expenses can be deducted.

How Can I Claim This Deduction?

If you use your home for your business and you file Schedule C (Form 1040), you should report the full deduction for the business use of your home on line 30 of Schedule C (Form 1040). If you used the standard method to calculate your deduction, you must complete and file Form 8829.

If you use your home for your farming business and file Schedule F (Form 1040), you should report the entire deduction for the business use of your home on line 32 of Schedule F (Form 1040).

Key Takeaways

  • A home office tax deduction allows qualified taxpayers to deduct certain home office expenses from their taxable income.
  • The definition of a "home" for tax purposes includes various types of properties, such as houses, apartments, condominiums, mobile homes, and even boats.
  • These tax deductions for home-based workers are available to self-employed individuals, entrepreneurs, independent contractors, and small business owners.
  • Eligible expenses that can be deducted include real estate taxes, mortgage interest, rent, utilities, insurance, depreciation, maintenance, and repairs.
  • To qualify for a home office deduction, certain criteria must be met, including exclusive use, regular use, use for trade or business, and the home office being the principal place of business.
  • The deduction can be calculated using either the simplified method (claiming a standard rate per square foot) or the standard method (based on the expenses directly and indirectly related to the home office).
  • To claim the deduction, taxpayers need to file Schedule C (Form 1040), and Form 8829 depending on the method used.

Maximizing your savings through home office tax deductions is a valuable opportunity. By understanding the criteria and rules surrounding this deduction, you can potentially keep more of your hard-earned money.