As an employee or small business owner, there are many expenses that you may be able to deduct on your tax return. The home office expense deduction is often one of the largest write-offs available. However, there are several IRS rules that restrict who can claim the deduction and what can be claimed.
TUTORIAL: Personal Income Tax Guide
Who Is Eligible?
Both employees and business owners are eligible to claim the home office deduction if they meet one of two criteria: the home office must either be the main place of business or the taxpayer must regularly and exclusively use the space for business purposes. In addition, employees must meet two additional criteria: the use of the space must be at the convenience of the employer, and the employee must not rent any space to the employer.
The first criterion is clear. If you have no other office space that you work out of and your home office is your only office, you qualify under this section. The second can be a little more gray in interpretation. A common example of regularly meeting clients in the home office is a lawyer or accountant. These professionals often have clients come to the home office after hours to sign documents and to meet with them. These home offices often qualify for the deduction as long as the space is not used for any other purposes.
The employee additional criterion that the space must be used at the convenience of the employer often means that the employer requires the employee to work at home. If the employee does it simply because it's easier, the deduction does not apply. If the employee rents the home office to the employer, he or she can deduct a portion of the house costs as rental expenses. (Knowing the tax deductions you're entitled to can make or break your bank account. For more, see Tax Deductions You May Be Missing.)
Which Expenses Are Claimable?
Most expenses related to the home office portion of the house can be claimed. There are three categories of expenses: those that relate solely to the home office (100% deductible), those that relate to the whole house (a portion of which is deductible), and those that relate solely to non-office parts of the house (not deductible). For example, if you paint the master bedroom of your house, the expense is not deductible at all because it has nothing to do with the home office. The electric bill, on the other hand, relates to the entire house and a portion of it can be deducted.
Common deductible expenses include heat, electricity, mortgage interest, property taxes, and repairs and maintenance. Employees are denied the deduction for the business portion of mortgage interest and property taxes, but can deduct both the business and non-business portion as a Schedule A personal itemized deduction. (For related reading, see Why You Should Itemize Your Tax Deductions.)
Calculating the Home Office Deduction
There are two ways to calculate the portion of expenses that can be deducted. The IRS allows the taxpayer to calculate both ways and to choose the one that provides the larger deduction. The first is to calculate the total square footage of the home office compared to the total square footage of the living area of the house. For example, if the home office is 100 square feet and the total home is 1,850 square feet, the home office percentage is 5.4%. This percentage is applied to the shared expenses of the house to arrive at the deductible portion. The second method is to count rooms. For example, if there are eight rooms in the house and the home office is one of them, the deductible percentage is 12.5%. In general, houses with small rooms will fare better under the first calculation and those with large rooms will provide a higher deduction using the second.
Tax Time Tips
If you are eligible to claim the home office deduction, it's important to keep all of your receipts handy for the end of the year. Often, repairs and maintenance expenses are missed because receipts have been lost or never received. The better you track your expenses, the more you will be able to claim.
If your home office space is part of a room, ensure that there is a clear division between the office and personal spaces. Use bookshelves, desks or other dividers to block off the space. You may have to prove to the IRS that you only use that space for business, so make sure there are no toys, musical instruments or other personal items in the space.
The Bottom Line
The home office deduction can be lucrative for small business owners and employees. Keeping receipts and carefully calculating the home office percentage ensures the highest possible deduction. (Homebodies can save big on their tax bill. For more, see How To Qualify For The Home-Office Tax Deduction.)