Even before the coronavirus pandemic, an increasing number of people worked from home. Technology gave 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 in pajama bottoms. Not only is this arrangement much more convenient for many workers, but it also allows some to take a tax deduction for the use of their homes as well. But only those who are self-employed.
In addition to being self-employed, you'll need to meet several other IRS requirements to be eligible for the home office tax deduction.
- The self-employed are eligible for the home office tax deduction if they meet certain criteria.
- The workspace for a home office must be used exclusively and regularly for business.
- Total deductible expenses can't exceed the income from the business for which the deductions have been taken.
- To calculate a home office deduction, you can choose between the standard method or the simplified option.
- Be accurate with your deduction in case you are audited.
Are You Self-Employed?
Are you working from home because you're self-employed? Independent contractors, sole proprietors of businesses, and freelancers are all self-employed persons. 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.
You may have to prove to the IRS via expense receipts and documentation that your home office is your primary workplace, so make sure to keep good records.
Is the Space Used Only for Business?
Is the workspace for your home office 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 the 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. 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.
Does Your Business Qualify?
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.
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.
How to Calculate the Home Office Deduction
There are two choices for calculating a home office deduction—the standard method or the simplified option.
Calculating the home office deduction using the standard method 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 (e.g., 14% from our example). Then the indirect expenses total is added to the total of the direct expenses.
The simplified option involves multiplying an IRS-determined rate by the square footage of your home office. To use the simplified option, your home office cannot be larger than 300 square feet, and you won't be able to deduct depreciation or home-related itemized deductions.
Deductions vs. Income
Do your deductions exceed your income? In order to qualify for the home office deduction, your total deductible expenses can't exceed the income derived from the business for which the deductions have been taken.
As an 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.
Who Is Considered Self Employed?
A self-employed person earns income by contracting with a trade or business directly versus working for an employer who pays them a consistent salary or wage. Sole proprietors, freelancers, and independent contractors are considered self-employed.
How Much Is the Self-Employment Tax?
The self-employment tax is 15.3%. The self-employed pay 12.4% for Social Security and 2.9% for Medicare. Remember that your self-employment tax is a deductible expense. The IRS will allow you to count half of the self-employment tax amount, the amount your employer usually covers, as a business deduction.
What Type of Workspace Qualifies as a Home Office?
The workspace must be used exclusively and regularly for business. If the workspace is used for both business and personal use, you can't take the home office deduction. Just because your workspace is in your living room, doesn't mean you can claim the entire room, especially if you use the room for anything other than business. It is important to be accurate in case you are audited.
The Bottom Line
It takes more than 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 on the IRS website; simply download the instructions for IRS form 8829.