The Home Office Deduction is still alive and well…don’t let any accountant tell you otherwise. It’s NOT a high risk write-off every good business owner should take advantage of it. Moreover, there are several strategies on how to maximize the Home Office Deduction and make sure you stay in good graces with the IRS as well as saving the maximum amount in taxes.
Before I get into the requirements and your options for deducting the home office, keep in mind that I’m sick and tired of hearing new clients and students of mine explain that their personal accountant is ‘afraid’ to take this deduction and explain it’s ‘high risk’. That simply isn’t true. As long as you are entitled to take it, aren’t too aggressive, and take use the proper method/strategy there is nothing to worry about. Even if you are audited, you shouldn’t shy away from taking a deduction when you are legally able to do so.
FIRST: The Requirements to Claim the Deduction
Before you can talk about ‘how’ you take the deduction, you want to make sure you ‘can’. There are two basic requirements for your home to qualify as a deduction:
1. Regular and Exclusive Use. You must regularly use part of your home exclusively for conducting business. Now I know the word ‘exclusively’ may concern you. However, as long as it isn’t your bedroom or the kitchen, even a portion of a studio apartment will qualify. Just make sure you have a desk and a computer reflecting the business use.
2. Principal Place of Your Business. I feel this is the more serious qualification, in that you must show that you use your home as your principal place of business. Thus, if you have ‘another office’ in town for your business, your home office may be off limits. However, if you conduct business at a location outside of your home, but also use your home substantially and regularly to conduct business, you may qualify for a home office deduction. For example, if you have in-person meetings with patients, clients, or customers in your home in the normal course of your business, even though you also carry on business at another location, you can deduct your expenses for the part of your home used exclusively and regularly for business.
NEW RULE!!! – The ‘Administrative office’ has evolved in various tax court cases over the past 2 years. This gives an option to the business owner that meets client/customers at a ‘main office’, but then comes home to return email, billing, do the books and various other administrative tasks.
TIP– If you have multiple businesses, i.e. a rental property business, use the home office deduction for this business and leave it alone for your primary or operational business.
SECOND: Two (2) Options to Calculate the Deduction
Generally, deductions for a home office are based on the percentage of your home devoted to business use. So, if you use a whole room or part of a room for conducting your business, you need to figure out the percentage of your home devoted to your business activities. However, the IRS has now come up with another option for completing the actual ‘calculation’.
1. Simplified Option. The simplified option can significantly reduce record keeping burden by allowing a qualified taxpayer to multiply a prescribed rate by the allowable square footage of the office in lieu of determining actual expenses. (Rather than the Regular Method – see below). There are several principal benefits of this relatively new option (since 2014):
- Business owners are allowed to take a deduction of $5 per square foot for the part of their home used for business (a maximum 300 square feet). So essentially $1,500 per year.
- This method still allows business owners to claim their mortgage interest and property taxes as Itemized Deductions on Schedule A without allocating a portion to the Home Office Write-off.
- There is NO requirement to recapture home office depreciation later when you sell your personal residence.
2. Regular Method. This is typically the better option if the business owner has a more expensive residence, home office design, or more square footage. Thus, it’s important to take advantage of the bigger write-off and not settle for the simplified option. However, it also takes more math and record keeping. The issues to consider include:
- Deductions for a home office are based on the percentage of your home devoted to business use multiplied by expenses to maintain the home.
- Allowable expenses include mortgage interest, insurance, utilities, repairs, and depreciation.
- You will be stealing deductions from your Itemized Schedule A deductions in order to maximize the Home Office write-off, but that may not be a bad thing with the new limits on Mortgage Interest and Property Taxes. See my article on the new “The New Home Mortgage Interest Deduction”.
- You will have to recapture the depreciation you took for the Home Office when you sale your home in the future.
- And…don’t forget the record keeping to justify those expenses you are taking.
A Word about S-Corporations
For those of you operating as S-Corporations, a standard industry practice is to calculate a fair home office ‘reimbursement’ amount and take a deduction for rent on the S-Corp tax return. The reimbursement is tax-free to you, and the rent is obviously a tax deduction for the S-Corp. However a couple important notes or requirements:
- Make sure the amount of the write-off you claim for ‘rent’ is not inflated and would be similar to the amount taken with the home office worksheet for a sole-proprietorship
- It’s also critical you have an “Accountable Plan” set forth in your Annual Minutes for your S-Corp. See my article “Maintaining Your S-Corporation”.
- If you are worried about ‘audit risk’, this is a great way to take the deduction in a much less visible manner and further reduce your chances of an IRS taking an interest in your deduction.
Bottom line, talk with your CPA and demand an aggressive position on this deduction. Don’t be talked out of taking it simply out of fear, but only if you clearly don’t qualify.
* To sign up for Mark’s weekly Free E-Newsletter and receive his Free E-Book “The Top 10 Best Tax Saving Secrets Everyone Should Know” visit www.markjkohler.com.
Mark J. Kohler is a CPA, Attorney, co-host of the Radio Show “Refresh Your Wealth” and author of the new book “The and Legal Playbook- Game Changing Solutions For Your Small Business Questions: 2nd Edition”, and “The Business Owner’s Guide to Financial Freedom- What Wall Street isn’t Telling You”. He is also a partner at the law firm Kyler Kohler Ostermiller & Sorensen, LLP and the accounting firmK&E CPAs, LLP.