Can You Deduct Home Office Expenses?

To deduct home office expenses from your taxable income, you must be self-employed and perform most of your business activities from a dedicated area in your personal residence. Unfortunately, that means remote employees don’t usually qualify.

Here’s a more detailed explanation of those rules to help you figure out whether or not you can take the home office deduction, plus a step-by-step guide to calculating the amount if you’re eligible.

Who Is Eligible to Claim Expenses?

You have to clear several hurdles before you’re eligible to claim home office expenses on your tax return. The one that prevents most people from taking the deduction is the requirement that you be self-employed.

If you’re working from home as an employee of someone else’s business, your home office expenses generally aren’t tax-deductible.

Employees could take a miscellaneous itemized deduction for an unreimbursed employee expense before 2018, but not anymore. However, your employer can still reimburse you for the amount and write it off themselves.

However, if you do have eligible business earnings, your ability to claim the home office deduction depends on how you use the space. To qualify, your home office must be:

• Exclusively for business use: You must have a home office that’s dedicated solely to your business activities. It can’t serve any personal function. For example, you can’t work in your dining room area and then try to claim the space as a home office.
• Principal place of business: You must do most of your work at your home office. If you rent commercial office space and only occasionally work from your personal residence, you won’t be able to claim any of your housing expenses using the home office deduction.

Fortunately, it’s not difficult to abide by these rules once you know them. For example, say you’re a freelance web developer and do all your work from your laptop.

You want to take the home office deduction, so you put a desk in the corner of your living room. Except for the rare occasions where you work at coffee shops, you do all your business from that desk and never use it for anything else.

What if You Have a Side Hustle?

Fortunately, you can qualify for the home office deduction through your side hustle.

Someone working as a full-time employee can still be a business owner or independent contractor in their spare time.

However, to be eligible, the side hustle must be a business, not just a hobby. To determine whether your side hustle is a legitimate business, the Internal Revenue Service (IRS) considers nine factors, including whether:

• You have personal motives in carrying on the activity
• You depend on income from the activity for your livelihood
• Your activities make a profit some years, and whether it’s large or small
• You were successful in making a profit in similar activities in the past

You can see IRS Publication 535 for more details, but the judgment is always a little subjective. Fortunately, the Internal Revenue Code safe harbor rule states an activity is presumed to be for a business purpose if it was profitable in three of the last five years.

If your side hustle is a business based on the considerations above, you can deduct the portion of your housing expenses that correspond with your home office. Of course, that’s assuming it’s your principal place of business and exclusively for business use.

Does Your Home Qualify for the Tax Benefit?

Fortunately, your housing arrangement generally doesn’t impact your ability to take the home office deduction. You can qualify for the tax break living in an apartment, condominium, or single-family house.

It’s also largely irrelevant whether you’re renting the residence, paying down its mortgage, or are already the sole owner. That only affects the size and kind of housing expenses you incur that are eligible for deduction.

Once again, the only variables that matter when determining whether your home and office qualify for the deduction are whether it’s your principal place of business and whether you use the office space exclusively for business.

How to Calculate the Amount

Business owners can calculate their home office deductions in two separate ways: the standard and the simplified methods. Here’s how to calculate the amount using both options.

Standard Option

The standard way to determine the home office deduction involves adding up your housing expenses and calculating which portion corresponds with your home office. Typically, that involves a simple square footage determination.

For example, say you incur the following indirect expenses for your housing during the year:

• $5,000 of mortgage interest
• $4,800 of depreciation
• $1,200 of utilities
• $2,800 property tax

In addition, you had $200 of direct expenses for repairs and maintenance in your home office. A direct expense gets specifically incurred for the area where you do business.

In total, your annual housing expenses are $14,000. To find the portion that corresponds with your home office, you’d count the square footage of your office and home. Say you find that the former is 100 square feet and the latter is 1,250 square feet.

100 divided by 1,250 equals 8%. Next, you can multiply the $13,800 of indirect expenses by 8% and add the $200 of direct maintenance to calculate a home office tax deduction of $1,304.

If you want to use the actual expense method, IRS Form 8829 can help guide you through each step in the calculation.

Simplified Option

The simplified way to calculate the home office tax deduction doesn’t necessitate that you track all of your housing expenses. Instead, you only need to know the square footage of your home office.

To calculate your write-off, just multiply the square footage of your home office by the IRS standard deduction, which is $5. If you use this method, you can have a home office no larger than 300 square feet for tax purposes.

For example, say you have a 150 square foot bedroom that serves as your business’s only office, and you never use it for anything else. Using the simplified method, you could take a home office deduction of $750.

Which Method Should You Use to Take the Deduction?

Usually, the standard home office expense calculation leads to a higher deduction than the simplified method. It correlates with your actual expense amounts, which can be pretty high with costs like rent, mortgage interest, and depreciation in the mix.

In addition, many home offices are small, which can lead to some underwhelming deduction numbers. Unless you have an entire room to spare, the space you can afford to designate exclusively for business use probably won’t be very big.

As a result, a common reason not to use the standard deduction method is that you don’t want to have to keep track of your housing expenses. Maybe you feel that way because you’re under the impression that it takes a lot of time and effort.

Fortunately, that’s not true. Lendio offers free accounting software for small business that automatically tracks your expenses and categorizes them. Connect the credit card or bank account you use for your housing expenses, and Lendio’s software can do the rest.

Because there’s no good reason not to keep track of your housing expenses, it’s usually a good idea to calculate your home office deduction using the standard and the simplified method, then use the one that gives you the highest.

Note that once you choose the standard or simplified method for a given tax year, you can’t change your mind later by filing an amended return. However, you can always choose to use the other method in future years.

Other Home Office Expenses That Are Deductible

In general, all the expenses you incur by owning or maintaining your personal residence during the tax year can contribute to the calculation of your home office deduction. That includes costs like the following:

• Rent or mortgage interest
• Homeowners Association (HOA) dues
• Condominium fees
• Repairs and maintenance
• Housing insurance
• Real estate taxes
• Depreciation
• Utilities

Note that expenses you incur to improve your property don’t qualify as maintenance, and you can’t deduct them in the year you pay for them. Instead, you may need to capitalize the amount as an asset and depreciate it over the asset’s useful life.

For example, say you pay $5,000 to replace the windows in your home. While that is a housing expense, it’s significant enough that you can’t deduct it immediately and represents a permanent improvement to your home.

As a result, you have to add it to the balance sheet as an asset and deduct it over the next 27.5 years. Using the straight-line method would generate a $182 depreciation expense each year.

Fortunately, the IRS issued a safe harbor rule, which states they generally won’t challenge you for expensing line items below $2,500 in an audit. You can use that as a rule of thumb to better assess when you need to capitalize certain expenses as assets.

Common Mistakes People Make When Claiming the Home Deduction

The home office deduction can be complicated, and there are many opportunities for taxpayers to mess it up. Some of the most common mistakes people make when claiming the home office deduction include:

• Skipping the deduction: Because the home office deduction can be difficult to calculate, some taxpayers find it too intimidating or think they might trigger an audit if they mess it up. As a result, they don’t even attempt to take the business expense. That can be a mistake because you may be leaving money on the table unnecessarily. You can always use the simplified method if nothing else.
• Using the wrong method: Choosing the simplified calculation option may be better than skipping the home office deduction entirely, but it’s often not the optimal choice. In many cases, taking the time to track your home expenses and expensing the business-related portion will create the highest possible deduction.
• Not having an eligible office: It’s not a given that your home office space is your primary place of work or set up exclusively for business use, even if you’re self-employed and eligible for the deduction. People often neglect one of those requirements and realize when it’s too late to do anything differently.
• Forgetting depreciation recapture: The home office deduction lets you write off the portion of the wear and tear your property experiences that correspond with your home office. However, it decreases your basis in the asset, which will increase your subsequent taxable capital gain if you ever sell the property.

If you need help with your home office expenses, a Certified Public Accountant (CPA) can offer you tax advice. They can help confirm that you’re eligible for the deduction and make sure you write off the proper amount.

To make tax time as easy as possible for both of you, use Lendio’s free small business accounting app. It automatically tracks and categorizes your expenses, so you can get organized and accurate financial records without opening your wallet. Try it out today!

*The information provided in this post does not, and is not intended to, constitute business, legal, tax, or accounting advice and is provided for general informational purposes only. Readers should contact their attorney, business advisor, or tax advisor to obtain advice on any particular matter.