2020 saw an unprecedented number of workers and businesses transitioning to a work-from-home model. If you work from home, you should know these important tax implications of setting up a home office.
Now that many of us are working remotely, you may be wondering whether working from home will yield any tax breaks. If your small business qualifies you for a home office tax deduction, should you be concerned about triggering an audit? How does a business qualify in the first place? This article will delve into the most common questions about this tax deduction.
If I work from home, do I qualify for a home office tax deduction?
If you're an employee working remotely rather than an employer or business owner, you unfortunately don't qualify for the home office tax deduction (however, please note that it is still available to some as a state tax deduction). Prior to the Tax Cuts and Job Acts (TCJA) tax reform passed in 2017, employees could deduct unreimbursed employee business expenses, which included the home office deduction. However, for tax years 2018 through 2025, the itemized deduction for employee business expenses has been eliminated.
If I'm self-employed, should I take the home office tax deduction?
You may have heard that taking the home office deduction sends a red flag to the IRS and ups your chances of being audited. Although there may have been some merit to this advice in the past, changes in the tax rules in the late 1990s made it easier for people who work out of their homes to qualify for these write-offs. So if you qualify, by all means, take it.
Do I qualify for the home office tax deduction?
Generally speaking, to qualify for the home office deduction, you must meet one of these criteria:
- Exclusive and regular use: You must use a portion of your house, apartment, condominium, mobile home, boat or similar structure for your business on a regular basis. This also includes structures on your property, such as an unattached studio, barn, greenhouse or garage. It doesn't include any part of a taxpayer's property used exclusively as a hotel, motel, inn, or similar business.
- Principal place of business: Your home office must be either the principal location of your business or a place where you regularly meet with customers or clients. Some exceptions to this rule include day care and storage facilities.
What is "exclusive use"?
The biggest roadblock to qualifying for these deductions is that you must use a portion of your home exclusively and regularly for your business.
The law is clear and the IRS is serious about the exclusive-use requirement. Say you set aside a room in your home for a full-time business and you work in it ten hours a day, seven days a week. If you let your children use the office to do their homework, you violate the exclusive-use requirement and forfeit the chance for home office deductions.
The exclusive-use rule doesn't mean:
- You're forbidden to make a personal phone call from the office.
- You have to rush outside whenever a family member needs a moment of your time.
Although individual IRS auditors may be more or less strict on this point, some advisers say you meet the spirit of the exclusive-use test as long as personal activities invade the home office no more than they would be permitted to in an office building. The office can also be a section of a room if the division is clear — thanks to a partition, for example — and you can show that personal activities are excluded from the business section.
What is "regular use"?
There's no specific definition of what constitutes regular use. Clearly, if you use an otherwise empty room only occasionally and its use is incidental to your business, you'd fail this test. If you work in the home office a few hours or so each day, however, you might pass. This test is applied to the facts and circumstances of each case the IRS challenges.
What does "principal place of business" mean?
In addition to passing the exclusive- and regular-use tests, your home office must be either the principal location of that business or a place for regular customer or client meetings.
If your home office is in a separate, unattached structure — a detached garage converted into an office, for example — you don't have to meet the principal-place-of-business or the deal-with-clients test. As long as you pass the exclusive- and regular-use tests, you can qualify for home business write-offs.
What if your business has just one home office, but you do most of your work elsewhere?
Remember that the requirement is that your home office is your principal place of business, not your principal workplace. As long as you use the home office to conduct your administrative or management chores and you don't make substantial use of any other fixed location to conduct those tasks, you can pass this test.
If you're an employee of another company but also have your own part-time business based in your home, you can pass this test even if you spend much more time at the office where you work as an employee.
This rule makes it much easier to claim home office deductions for individuals who conduct most of their income-earning activities somewhere else (such as outside salespeople or tradespeople).
What qualifies as a business?
As with the regular-use test, whether your endeavors qualify as a business depends on the facts and circumstances. The more substantial the activities, in terms of time and effort invested and income generated, the more likely you are to pass the test.
Making money from your efforts is a prerequisite, but for purposes of this tax break, profit alone isn't necessarily enough. If you use your den solely to take care of your personal investment portfolio, for example, you can't claim home office deductions because your activities as an investor don't qualify as a business.
Taxpayers who use a home office exclusively to manage rental properties may qualify for home office tax status but as property managers rather than investors.
What if I operate a child care or storage facility?
The exclusive-use test doesn't apply if you use part of your house to:
- Provide day care services for children, older adults or individuals with disabilities. If you care for children in your home between 7 a.m. and 6 p.m. each day, for example, you can use that part of the house for personal activities the rest of the time and still claim business deductions. To qualify for the tax break, your home care business must meet any applicable state and local licensing requirements.
- Store product samples or inventory you sell in your business. Assume your home-based business is the retail sale of home-cleaning products and that you regularly use half of your basement to store inventory. Occasionally using that part of the basement to store personal items wouldn't cancel your home office deduction. To qualify for this exception, your home must be the principal location of your business.
How do I calculate the home office tax deduction?
Your home office business deductions are based on either the percentage of your home used for the business or a simplified square footage calculation.
The most exact way to calculate the business percentage of your house is to measure the square footage devoted to your home office as a percentage of the total area of your home. If the office measures 150 square feet, for example, and the total area of the house is 1,200 square feet, your business percentage would be 12.5%.
An easier calculation is acceptable if the rooms in your home are all about the same size. In that case, you can figure out the business percentage by dividing the number of rooms used in your business by the total number of rooms in the house.
Special rules apply if you qualify for home office deductions under the day care exception to the exclusive-use test.
- Your business-use percentage must be reduced because the space is available for personal use part of the time.
- To do that, you compare the number of hours the child care business is operated, including preparation and cleanup time, to the total number of hours in the year (8,760).
Assume you use 40% of your house for a daycare business that operates 12 hours a day, five days a week for 50 weeks of the year.
- 12 hours x 5 days x 50 weeks = 3,000 hours per year.
- 3,000 hours ÷ 8,760 total hours in the year = 0.34 (34%) of available hours.
- 34% of available hours x 40% of the house used for business = 13.6% business write-off percentage.
Simplified square footage method
Beginning with 2013 tax returns, the IRS began offering a simplified option for claiming the deduction. This new method uses a prescribed rate multiplied by the allowable square footage used in the home.
- For 2020, the prescribed rate is $5 per square foot with a maximum of 300 square feet.
- If the office measures 150 square feet, for example, then the deduction would be $750 (150 x $5).
- The space must still be dedicated to business activities.
With either method, the qualification for the home office deduction is determined each year. Your eligibility may change from one year to the next. Finally, please note that only certain expenses such as rent, mortgage interest and property taxes qualify for the deduction, and the deduction is limited to $10,000.
Which method should I use to calculate my home office deduction?
The simplified method can make it easier for you to claim the deduction but might not provide you with the biggest deduction. TurboTax makes it easy to determine if you qualify and how much you can write off by asking you simple questions about your unique tax situation. TurboTax has you covered whether your tax situation is simple or complex. We’ll help you find every deduction you qualify for and get you every dollar you deserve.