Home Office Deduction

Will taking the home office deduction trigger an audit? The answer is generally, no. It was once a key target, but in 1999 Congress clarified the rules and allowed more taxpayers to take this deduction. So if you qualify, by all means, take it.

Because the home office deduction is easy for people to abuse if they are not careful, you have to make sure you are disciplined in how you use your home office, and follow the rules closely.

Note: If you use TurboTax software to prepare your taxes, we'll ask you a few simple questions to see if you qualify, then calculate this deduction for you.

What You Need to Know

First, we'll review the tax situation for sole proprietors and single-member LLCs, then we'll look at how corporations, partnerships, and multi-member LLCs should handle the home office deduction.

Note: The qualification for the home office deduction is made each year. There is no long-term penalty if you don't qualify in a particular year.

Sole Proprietors, Single-Member LLCs

The home office deduction is allowed if the space used for an office or to store inventory satisfies two basic rules:

• The office space is used as the principal place of business for meeting clients or customers and/or performing the administrative tasks required for the business
• The office space is used exclusively for business purposes; no personal use (e.g., paying personal bills online or helping your children with homework on the office computer, relaxing there in the evening to read or watch TV, etc.)

Note: A portion of your rent or mortgage interest, property taxes, utilities, and repairs may be deducted as part of the home office deduction. The deductible portion is based on the square footage of the area used for business as a percentage of the total square footage of the home.

For example:

A home of 2,000 square feet with an office of 200 square feet would result in 10% of certain expenses that can be deducted as home office expenses on Form 8829.
$9,000 Mortgage Interest
$2,500 Property Taxes
$600 Home Insurance
$750 Home Repairs

Total $12,850

$12,850 x 10% = $1,285 deductible as business expenses

Mortgage interest and property taxes that are not deducted as home office expenses (90% of $9,000 and $2,500) are still deductible as itemized deductions on Schedule A.

Note: Daycare providers need to enter additional information about their hours of operation.

Here are the numbers you will need to calculate this deduction:

• Total square footage of your home (or apartment)
• Total square footage of your office space

TurboTax Tip: Here's a math refresher: Length x Width = Total Area

Corporations, Partnerships, and Multi-Member LLCs

Individual owners of S corporations, partnerships, and multi-member LLCs may also be able to take a deduction for home office expenses if they qualify.

S Corporations

The shareholder using his or her home office as the only business office can claim the deductions on a personal return. (Form 8829 is used to calculate the deductible amount; the deduction may be claimed as a Miscellaneous Itemized Deduction on Schedule A.)

Alternatively, the S corporation may pay rent to the shareholder for use of the home office. The income and expense would then be treated as rental activity and entered on Schedule E of Form 1040. If the shareholder is active in the S corporation, the activity is considered non-passive and is not subject to passive loss limitations.

For more information, see the TurboTax Business Rental Income Help Center or IRS Publication 925: Passive Activity and At-Risk Rules.

Partnerships and Multi-Member LLCs

The partner (or LLC member) using the home office as the business's only office can claim the deductions on the personal return (on Schedule E).

Alternatively, the partnership/LLC may pay rent to the partner for use of the home office. The income and expense would then be treated as a rental activity on Schedule E of Form 1040. If the partner is an active member of the partnership/LLC, the activity is considered non-passive.

TurboTax Tips:

• If you generally have to pay the Alternative Minimum Tax (AMT) when you itemize deductions, a home office deduction may be a factor contributing to your AMT status. If so, you may want to forego the home office deduction.
• If you include home depreciation as part of the home office deduction and eventually sell your home at a profit, you will have to pay a capital gains tax on the total amount of depreciation deductions you took while you were living there (this tax does not apply to other deductions you took).

The Bottom Line

• The home office deduction is no longer a red flag for an IRS audit.
• Whether you qualify for this deduction is determined each year.
• Deducting a home office is treated differently depending on your business type.