Working from home is becoming more and more popular. And while W-2 employees are no longer eligible to deduct their home expenses, those who own or co-own a business can take advantage of the deduction. Here’s what you need to know about the home office deduction and how you might be able to use it for your situation.
Who Can Take the Home Office Deduction?
Taxpayers can take this deduction if they use a portion of their home exclusively, and on a regular basis, for any of the following:
- As the taxpayer’s main place of business
- As a place of business where the taxpayer meets patients, clients, or customers in the normal course of business
- As the sole, fixed business location where inventory or samples are stored
- As the structure, under certain circumstances, where the taxpayer provides daycare services
Taxpayers can also take the deduction if the space is a separate structure that is not attached to the taxpayer’s home and that is used in connection with their business.
What Is Deductible?
Deductible expenses for business use of an area of the home include:
- Real estate taxes
- Mortgage interest
- Casualty losses
- Repairs and maintenance
Certain expenses are limited to the net income of the business. These are known as “allocable expenses.” They include things such as utilities, insurance, and depreciation. While allocable expenses cannot create a business loss, they can be carried forward to the next year. If the taxpayer carries them forward, the expenses are subject to the same limitation rules.
Which Method: Simplified or Regular?
There are two options for figuring and claiming the home office deduction:
- Regular method: This method requires dividing the above expenses of operating the home between personal and business use. Self-employed taxpayers file Form 1040, Schedule C and compute this deduction on Form 8829.
- Simplified method: This method reduces the paperwork and recordkeeping for small businesses. The simplified method has a set rate of $5 per square foot. The highest deduction allowed is based on a maximum of 300 square feet.
Here is a comparison of the two options:
|Simplified Option||Regular Method|
|Standard $5 per square foot||Actual expenses determined and records maintained|
|Allowable only up to 300 square feet||Actual percentage of home used for business|
|Deduction for home office use of a portion of a residence allowed only if that portion is exclusively used on a regular basis for business purposes||Same|
|Allowable home-related itemized deductions claimed in full on Schedule A (e.g., mortgage interest)||Home-related itemized deductions apportioned between Schedule A and business schedule (Schedule C or F)|
|No home depreciation deduction||Depreciation deduction for portion of home used for business|
|No recapture of depreciation upon sale of home||Recapture of depreciation on gain when home is sold|
|Deduction cannot exceed the difference between gross income from business use of home and business expenses||Same|
|Amount in excess of gross income limitation may not be carried over||Amount in excess of gross income limitation may be carried over|
|Loss carryover from use of regular method in prior year may not be claimed||Loss carryover from use of regular method in prior year may be claimed if gross income test is met in current year|
When considering which method to use, keep the following in mind:
- You may choose to use either the simplified method or the regular method for any taxable year.
- You choose the method by using that option on your timely filed, original federal income tax return for the taxable year.
- Once you have chosen a method for a taxable year, you cannot later change to the other method for that same year.
- If you use the simplified method for one year and the regular method for any subsequent year, you must calculate the depreciation deduction for the subsequent year using the appropriate optional depreciation table. This is true regardless of whether you used an optional depreciation table for the first year the property was used in business.
How to Claim the Deduction
Which form to use differs depending on the type of business:
- Daycare providers complete a special worksheet, found in Publication 587.
- Self-employed individuals use Form 1040, Schedule C, Line 30 to claim deduction.
- Farmers claim the home office deduction on Form 1040, Schedule F, Line 32.
The home office deduction is just one of the tax benefits available to small business owners. Call your CRI tax advisor to discuss how to maximize your tax benefits and improve your bottom line.