Has your friend, neighbor or colleague told you that if you take the home office deduction, it will be a “red flag” to the IRS that will trigger an audit? Well, that is just not true! In order to claim the home office deduction, you MUST QUALIFY, but if you do qualify, there is no reason not to take it. To qualify, you are required to meet 2 tests: regularly used and exclusively used for business.
- Regular Use: this test is clear – you use the area on a continuing basis. This doesn’t mean every day, but it is used consistently.
- Exclusive Use: a specific part of a taxpayer’s home is used for business only. There is no requirement that the business portion of a room be physically separated by a wall or partition. But, any personal use of the space, no matter how small, means that it is not exclusive. There are two exceptions: storage space and daycare facility.
You can have more than one office. Your home can qualify as a principal place of business if:
- The office is used regularly and exclusively for administrative or management activities (billing clients, keeping books, ordering supplies, setting appointments, writing reports).
- There is no other fixed location where the taxpayer conducts these activities.
A business use of the home deduction may be allowed if the taxpayer meets clients in their home. For example, if an attorney works 4 days a week in his downtown office and 1 day at his home office, he can deduct the home office if he meets with his clients there too. It will qualify for the deduction even though it is not the principal place of business.
Another benefit of having a qualifying home office is that the miles that you drive from your home to the first business stop is now deductible. If your home is not the principal place of business, your first stop is considered commuting and not deductible.
There are three buckets of expenses:
- Expenses that directly impact the home office are 100% deductible. For example, you paint or carpet only the home office.
- Expenses that are not related to the home office are 0% deductible. For example, you paint your kitchen.
- Most home office expenses are based on the business percentage. The easiest way to determine the business percentage is to take the total square footage exclusively and regularly used for business and divide that by the total square footage of your home. Below are some expenses that might be allocated by the business percentage:
- Mortgage interest
- Property taxes
- Utilities (gas, electricity, garbage)
- House insurance
- Security system
- Home maintenance/repairs
- Depreciation (straight line method over 39 years)
- Other qualifying expenses
If your total income is less than your total expenses, your home office deduction for certain expenses will be limited. However, these deductions can carry over the next year. Be aware of that carry over number if this happens in your situation.
If you take depreciation on your home office and you sell your home, you have to “recapture that amount”. What this means is that the amount you deducted for depreciation reduces your ordinary income – this is good. But when you sell your home, that amount will increase your capital gains. The capital gains rate is typically less than your personal income tax bracket.
If your business is reported on Schedule C of your Form 1040 (sole proprietors and some single member LLC’s), you will report home office costs on form 8829,
What about S-Corps and C-Corps which don’t have a Form 8829? In those cases, we recommend the company to set up an accountable reimbursement plan and to hace the shareholder employee reimbursed through the accountable plan.
There are other opportunities to use your home for deductions for small business owners such as using “The Augusta Rule”. We’ll discuss the Augusta rule in more detail in the future.
When you know the rules, there should be no fear around taking a deduction that you qualify for. So…do you qualify? If so, take the deduction, reduce your taxes and don’t worry about that “red flag” because if audited, there will be no change on your return because you know the rules!
Call us at (972) 821-1991 to learn more and see if you qualify!