Home Office Deduction: Guide to Home Office Tax Deduction
In today’s world, working remotely is becoming the norm. Small businesses across the country are shuttering up their office spaces and opting to work from home. Along with this new working environment comes the need for certain adjustments. Many small business owners and self-employed individuals have opted to set up a home office to increase their privacy and keep productivity at an all-time high.
If you’ve recently set up a home office, you need to know about the home office deduction. Read on to learn about this work-from-home deduction and how to calculate your deductible expense.
What Are Deductions?
Before we dive into the home office deduction, let’s cover the basics. What are deductions?
Deductions are expenses that you incur over the course of the year that can allow you a break from your taxes. All taxpayers are able to deduct the cost of any qualifying deduction from the total amount of their taxable income, lowering their tax liability.
Let’s say you made $40,000 in taxable income last year and paid $2,000 in deductible expenses. Come tax season, you’ll be able to deduct the $2,000 in expenses from your $40,000 in taxable income. Rather than paying taxes on all $40,000, you’ll only need to pay taxes on the remaining $38,000.
Itemized Deductions vs Standard Deductions
You may be wondering, “Why have I never dealt with deductions before?” If you’ve historically been a W-2 employee and haven’t incurred a lot of qualifying deductions throughout the year, you probably claim the standard deduction each year.
The standard deduction is a set amount established by the IRS that each taxpayer can claim each year without having to show any proof, like receipts or bank statements. It is an average amount that the IRS determines most taxpayers likely pay in deductible expenses each year. For 2020, the standard deduction was "$24,800 for married couples and $18,650 for heads of household."
For those who incur a number of deductible expenses each year, such as those who are self-employed, the standard deduction is most likely far less than the amount they pay in deductible expenses each year. For these taxpayers, the IRS offers the option to itemize expenses. That means these taxpayers can claim itemized deductions which include the cost of qualifying expenses, dollar for dollar, from their tax liability. The only requirement is that they provide proof of every expense and calculate exactly according to the IRS’ instruction.
What is the Home Office Deduction?
If your business operates out of a home office, you may qualify for the home office deduction. This is a deduction that the IRS makes available to homeowners and renters alike who utilize a portion of their home for their business operations. If you’re looking for work-from-home tax deductions that benefit your new arrangement, this is a good place to start.
Qualifying for the Home Office Deduction
You may qualify for the home office deductions if you meet the following requirements. Note that, if you meet one of the following requirements but use a separate structure on your property, such as a studio, workshop, or garage, you likely still qualify for the home office deduction.
Regular and Exclusive Use
You use a designated portion of your home, such as a home office or a spare bedroom, regularly and exclusively for running your business. This means that you must use your office or spare room regularly for business and neither you nor your family members can do anything else in there. Note that the IRS does not specify what qualifies as “regular” use, but if you only use this space once or twice a month, it likely does not qualify.
Principal Place of Your Business
The designated area of your home is the principal, or main, place that you conduct business. While you may occasionally operate outside of your home, the principal place of business is where your books and records are kept, and the primary place of operation.
Your home office also may qualify as your primary place of business if it is the sole place that your business’s administrative or management services occur or you have no other fixed location where these activities take place.
A Place to Meet Patients, Clients, or Customers
Do you use your home to meet with clients, patients, or customers? If so, you may be able to deduct the cost as a home office expense. In order to qualify, you’ll need to meet with clients, patients, and customers physically. Virtual meetings do not count.
Storage of Inventory or Product Samples
Does a part of your home double as a warehouse? If you use a portion of your home exclusively to store your inventory or samples of your product, you can deduct your storage space as a part of the home office deduction, as long as you meet the following requirements:
- You sell products as your business
- You store said products in your home
- Your home is the only fixed location of your business
- You use the storage space regularly
How Much Can I Deduct?
Generally speaking, the IRS allows a certain deduction based on the size of your home office. You can either calculate the home office deduction based on the square footage of your home office, or you can calculate it based on the percentage of your home that is designated as your home office.
Calculating the Home Office Deduction
The two different ways to calculate your home office deduction are known as the simplified option and the regular method. Let’s review each.
The aptly named simplified option is the easiest way to calculate your home office deduction. This is the standard deduction for an office in your home. To use this method, you’ll multiple $5 by the square footage of your office, up to 300 feet. Next, you’ll determine any expenses that are unrelated to the use of your business (more on that later). The final figure can be deducted as your home office deduction.
In order to use the regular method to calculate the home office deduction, you’ll first need to determine the percentage of your home that is dedicated to your home office. For instance, if your home is 1,000 square feet and your home office is 100 square feet, your home office is 10% of your home.
Next, you’ll need to make a list of all qualifying home office expenses (more on that later). Finally, you’ll multiply each qualifying home office expense by your home office percentage. The final calculation is the amount that you can deduct.
For instance, if you have $1,000 in qualifying home office expenses, you’ll calculate that by the 10% figure. Your final deductible expense is $100.
What Are Qualifying Home Office Expenses?
Home expenses fall into three different categories as they relate to the home office deduction: direct, indirect, and unrelated. Add these expenses together to calculate the total cost of your qualifying home office expenses. Those home office expense deductions are as follows.
These are expenses that only apply to the business part of your home. These include things like repairs to or a new paint job on your home office. The full value of these expenses can be included as part of your home office expenses.
These are expenses that apply to the whole of your home—including your home office—but are not specific to your home office. These include things like your mortgage or rent, insurance, utilities, and more. To calculate these for your home office expenses, you’ll need to multiply them by the percentage of your home that is used for your office.
For instance, if your mortgage is $200 each month and your home office is 10% of your total home, you’ll calculate these two numbers to include $20 to your qualifying home office expenses.
These are expenses that are unrelated to your home office. They include things like mowing your lawn or repairs made to your kitchen. Their completion has no relation to the conduct of your business. These are not deductible as part of your home office expenses.
Other Tax Deductible Home Improvements
Did you know that many of your home improvement projects, including your home office, may be deductible come tax season? If you’ve performed any of the following tax-deductible home improvement projects, learn how to utilize them come tax season:
- Energy-efficient upgrades
- Upgrades to store solar energy at home
- Installing fuel cell power systems
- Utilizing geothermal heat pumps
- Installing residential wind turbines
- Accessibility upgrades
- Ramp and stairlift installation
- Widening hallways and doorways
- Installing handrails and grab bar fixtures
Learn more about how to utilize these technologies, other home energy savings tips, and how to finance your next energy-efficient upgrade through Ygrene.