The technological revolution has given rise to the personal computer, the internet, email, file sharing, and video conferencing. Put all these together and you have the makings of a home office. This is a place where you can do all the things you do at work, but now in pajama bottoms. Not only is this arrangement much more convenient for workers, but it also allows some of them to take a tax deduction for the use of their homes as well. However, only those who are self-employed.
Forced to work at home during the COVID-19 pandemic? Unfortunately, that does not qualify you to write off your workspace as a "home office." Only those who are self-employed can qualify, following the passage of the 2017 Tax Cuts and Jobs Act. This article will give you four tests that you must pass before you can deduct your home-office expenses. It will also show you what and how much you can deduct.
Test 1 - Is the space used only for business? The first test that must be applied to any home office is whether the workspace is used exclusively and regularly for business. Both of these criteria must be met in this test before any deduction can be taken. Put simply, if the workspace is used for both business and personal use, it is not deductible. Furthermore, the space must be used on a regular basis for business purposes; a space that is used only a few times per year will not be considered a home office by the IRS, even if the space is used exclusively for business purposes.
These criteria will effectively disqualify many filers who try to claim this deduction but are unable to prove regular and exclusive home office use. However, it is not necessary to partition off your workspace in order to deduct it, although this may be helpful in the event you are audited. A desk in the corner of a room can qualify as a workspace, as long as you count only a reasonable amount of space around the desk when computing square footage.
The only exception to the exclusive-use test applies to filers who provide daycare services for children or part of the home is used for storage of inventory. In this case, the home would regularly be used for daycare, but not exclusively, because those receiving care are only there during the day. Therefore, home daycare expenses are computed by portioning out the square footage of the home versus the area used for daycare and the number of hours the area is used for daycare versus the number of hours in the year (8,784/yr). Utility rooms such as laundry and storage rooms may be deductible under certain conditions as well.
Test 2 - Are you working from home because you're self-employed? The second major test that must be met is whether your home office is part of your business as a self-employed person or whether your employer happens to be allowing you to work from home because of coronavirus restrictions. So if you're working from home because of the COVID-19 pandemic, but normally work in an office, you can't qualify for the home office deduction.
Independent contractors may have to prove this to the IRS via expense receipts and documentation stating that their home office is their primary workplace.
Test 3 - Do all of your businesses comply? Filers who have more than one home-based business must be careful when claiming the home-office deduction. If any of their different lines of business don't meet the above criteria, then no home office deduction can be taken for any of them. It's an all-or-nothing proposition; the home office expenses incurred for each separate line of business must meet the above criteria on a standalone basis, and if one line fails, then all others fail as well.
Note: People who do not qualify for the home-office deduction may still deduct all other standard business deductions. For more information on these deductions, go to the IRS website and download the instructions for IRS Form 2106 and Schedule C.
Congratulations! The Hard Part Is Over
Now that you have made it this far and passed the first three tests, some calculations must be done before you can move onto the final test. This involves completing IRS Form 8829 to compute the actual amount of the deductible home-office expenses.
The first step in computing expenses is to determine the square footage of the workplace and divide that by the total square footage of the home. Here is a simple example:
- Step 1: Calculate the square footage of your home office. If your home office is a 15 ft by 15 ft room, then its total square footage is 225 square feet (15 ft x 15 ft = 225 square feet).
- Step 2: Find out the square footage of your home. For our example let's say your home has a total area of 1,600 square feet.
- Step 3: Now divide the area of your office by the area of your house. Ex. 225/1,600 = 0.14 (or 14%). This decimal represents the percentage of your total home expenses that can be allocated toward the home office deduction.
After you figure out the percentage of your household expenses that can be written off, you must list all of the expenses that pertain to your entire home, such as mortgage interest, real estate taxes, insurance, utilities, and depreciation for the year under the section titled "indirect expenses" of Form 8829. Expenses that are incurred solely for the benefit of the office space are then listed under the "direct expense" section of the form. The indirect expenses are totaled and multiplied by the percentage derived earlier (ex. 14% from our example). Then the indirect expenses total is added to the total of the direct expenses.
Final Test - Do deductions exceed income? Luckily, and unlike in school, the final exam for home office deductions is the easiest exam to pass. To complete this "income" test you must make sure that the total deductible expenses don't exceed the income derived from the business for which the deductions have been taken. For example, if total deductions come to $1,200, yet you only earned $950 of income from the business, then only $950 of deductions can be taken for that year. However, the remainder can be carried forward to a future year and deducted when business income exceeds expenses.
This final number is then used in either Schedule C for self-employed filers or Form 2106 and then to Schedule A for employees. The latter group must also be able to itemize deductions, and then home office deductions are totaled with all other unreimbursed employee expenses and must exceed a 2% adjusted-gross-income threshold in order to be deductible.
The Bottom Line
It takes more than a "Hang in there, kitty" poster and a personal computer to classify your spare bedroom as a home office. If you want to avoid a very unpleasant audit, you must understand the home-office deduction rules, and you must apply them correctly to properly claim your deduction. More information on home office deductions can be found at the IRS website, simply download the instructions for IRS form 8829.