Do you work from home? If so, others share your situation. The U.S. Small Business Administration says 60.1% of all firms without paid employees are home-based. The same ca be said for 23.3% of small employer firms, and 0.3% of large employer firms. Work from home? Determine whether to claim a home office deduction, which effectively transforms some personal expenses into business write-offs.
Make Sure You Qualify
There are two tests to pass before you can figure a home office deduction:
Test one: You must use the space in your home as your principal place of business. You meet this test if you do substantial administrative work at home even though you conduct business outside the home (e.g., at customer locations), provided you don’t maintain an office other than in your home. Alternatively, the home office satisfies the test if it’s used to meet with customers, clients, or patients in the normal course of business even though you have another business location. A free-standing structure, such as a studio or greenhouse, can also be a principal place of business.
Test two: You must use the space in your home regularly and exclusively for business. It doesn’t have to be a separate room or even have a physical partition, but the area can’t be used for personal purposes.
Two Ways to Take a Home Office Deduction
Once you meet the two tests, then decide how to figure your home office deduction. One way is hard; the other is easy. The hard way is to deduct actual expenses, and the easy way is to rely on the IRS standard deduction.
Deduct Actual Expenses
To deduct actual expenses, you have to make an allocation for the space in your home that you use regularly and exclusively for business. Then factor in both direct and indirect expenses.
For example, if you use one room for your home office — a bedroom that you’ve converted into an office let’s say — and you paint it, that’s a direct cost. You’re only dealing with the home office in that case so you can deduct the entire expense.
If, on the other hand, you’re talking about the mortgage or utilities, that’s an indirect expense, and you can only take a percentage based on the square footage your home office represents. And, because of the limitation on deducting state and local taxes as a personal itemized deduction, there are added complications for figuring the portion of real estate taxes factored into the home office deduction when you own your own home. Similar complications apply to home mortgage interest and casualty losses.
Review all of the records and receipts you have for expenses related to your home—mortgage interest, utilities, homeowner’s insurance, security monitoring, home repair warranties, depreciation and more—to determine which and to what extent they factor into your home office deduction. And retain this information with tax records.
Use IRS Standard Allowance
If trying to figure out actual expenses seems too complicated or you just don’t have the records to make computations, you can rely on an IRS created a standard allowance — $5 per square foot up to 300 square feet. It does not take into account what your expenses actually are. If your actual expenses produce a larger deduction than under the IRS standard allowance, it makes sense to go through the trouble of computing the home office deduction using your actual expenses.
Home Office Deductions an Audit Risk?
Many believe taking a home office deduction creates an audit red flag. But this may prove to be unwarranted. The IRS remains silent on whether it’s particularly focused on this deduction. And the overall audit risk for individuals seems very low. According to the 2018 IRS Data Book, the IRS only audited 0.59% of individuals that year. And consider the current IRS budget, personnel, and other tax focuses. For example, the IRS continues implementing new laws and servicing taxpayers. So the agency seems unlikely to increase this rate anytime soon.
If you work from home and meet the two tests for eligibility, taking a home office deduction should be routine. To learn more about the home office deduction, see IRS Publication 587.