There’s more interest in the Home Office Deduction than ever before and justifiably so. With the ‘great resignation’, there has been the ‘great formation’. More Americans than ever have a home office with a side-hustle or even a full-time business operation!
According to a recent Stanford Study, it’s estimated that more than 47% of full-time workers now work from home. Also, almost twice as many employees are working from home as at work.
As such, millions of Americans are wondering if there could be a tax deduction in all of this for the ‘wear and tear’ on their floors, furniture, and refrigerator.
The good news and bad news about Home Office Deductions
First, the bad news. If you are an employee, and do not have any type of side-hustle or small business, your’re not going to have a write-off.
Under current U.S. tax law, there is no longer a deduction for ‘unreimbursed employee expenses’. This means that when you are forced to work from home and paid as an employee with a W-2. There’s no write-off for the cost of you sharing your home supplies, equipment or space. I’m sorry. However…there are options. Please read on.
If you can talk your employer into it, IF they do reimburse you for the ‘cost’ of you sharing your wonderful home as a new corporate workspace. Those reimbursements are typically tax-free. Otherwise stated, the company gets a tax deduction. You, the employee, don’t have to include the income in your W-2.
However, if any of those funds exceed a fair ‘cost’ reimbursement, it could turn into rental income. It could possibly even be included in your W-2 (we certainly want to avoid either of those issues if possible). Make sure to talk with your employer about the options for the amount and how to catagorize it properly.
The Truly Good News for a Home Office Deduction
The best option, and the truly good news, is that if you have any type of small business you more than likely qualify for the home office deduction.
In fact, I will encourage you and WANT you to take the home office deduction. At the least, it will be as a deduction supporting your side-hustle, rental property business, or any 1099 you might be earning.
That’s right! I want and need you to have a side-gig or side-hustle in your life. This opens the door to many powerful write-offs, including that treasured home office deduction.
In fact, chances are you already have some sort of side-gig and may not even know it. This could include anything from driving for Uber, selling a product online, providing a service business, or part-time consulting.
And yes…again…a “side-hustle”, or “side-gig”, with any type of 1099-NEC is code for “Small Business”. NOW we can talk about the home office deduction and I want you to take it!
Dispelling the Myth that it’s a Risky deduction
Bottom line, it’s not a risk to take the home office deduction if you do it right – period!!
So, before I get into the requirements and your options for deducting the home office, keep that fact in mind. I’m sick and tired of hearing new clients and students of mine explain that their personal accountant is ‘afraid’ for them that they may get audited. Hence, they encourage their cliente to not take the deduction and explain that it’s ‘high risk’. That simply isn’t true.
As long as you are entitled to it… take it! But it’s true….don’t get greedy or too aggressive. Make sure to use the proper method or strategy that’s best for your situation. Even if you are audited, you shouldn’t shy away from taking a deduction, when you can legally do so.
One more reason why to take the home office deduction – Your auto!
There’s another incredible reason for even a conservative home office deduction: it opens the door to a great auto deduction!
Think about it. Mileage commuting to and from work, as well as for the personal use of your vehicle is not a write-off. However, if you have a “home office” (no matter how small) for your side-gig (aka. small business)…you can now you can justifywriting off A LOT more auto mileage when leaving the home office to pursue your side-gig.
Moreover, don’t overlook the benefit of the home office to justify so many other expenses that come with it! Maybe it could be equipment, supplies, electronics, storage, and of course the auto mileage. Think outside of the box when you have a side gig!
You have a small business office or worksite 10 miles from your home. When you set up a home office as a principal place of business (or Administrative Office- see below), you convert the commuting (typically not deductible) from your home to your second office into business miles. The elimination of your commute creates 5,000 business miles by year-end (20 miles a day round trip, 5 days a week, 50 weeks a year). With the deductible business standard mileage rate in 2022 of .585 cents multiplied by 5,000 miles, that’s an extra $2,925 deduction that you wouldn’t have without the qualifying home office.
Need I quote the CPA, Christian Wolff, played by Ben Affleck in one of the opening scenes of “The Accountant”? Christian gives his farming clients a little tutorial on the home-office deduction. He does take a few liberties with the “exclusive use test” (see below). But, he still certainly nails the concept.
The bonus for us nerdy accounts with the character Christian Wolff, is that we finally have a hero other than Rick Moranis in the 1984 version of “Ghostbusters”.
FIRST: The Two(2) 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. You have to meet BOTH of them:
1. Regular and Exclusive Use.
This is the most difficult test to satisfy and one where the IRS finds most of its leverage. First the technical rule: A taxpayer/business owner must regularly use part of your home exclusively for conducting business. Now I know the word ‘exclusively’ may concern you. Many people don’t have a space that is dedicated exclusively to business. There’s a good chance you might go into the room at night in your underwear eating cereal and watch a movie or return an email to your grandma. However, there are two exceptions that may still open the door for taxpayers to meet the exclusivity test.
- In the Miller v Commissioner case the Court recognized that the exclusive use rule can be difficult for owners of small homes, and they forgive you for what they call “de minimis” personal use. In a practical sense, this means that you can set up your office in an area that you must walkthrough for personal reasons, but still consider it an exclusive space for business. For example, in the Hughes case, the court allowed the taxpayer to have his office in a walk-through closet, even though he had to pass through the space to get to the bathroom. However, the Court in the Elmer Stalcup case denied the de minimis exception in a situation where a taxpayer used the space to store personal items, and in the Stengpiehl case when a taxpayer used the space occasionally to host family meals. Think of the de minimis rule as a walk-through rule. Essentially, if you simply pass through the area, you can use it for office space. If you use the space for personal reasons, you probably violate the exclusive use rule.
- If you live in a small home even rent a studio apartment, you can still qualify for the home office deduction and create an ‘exclusive space’ for the business. Consider the example in the Albert Mills case, where the taxpayer created a court-approved home office for 23 percent of his 422-square-foot home. For example, some people have suggested a type of ‘mini office’ where you can pull it out or fold it up when needed. This could even be a cabinet that may only take up 6-8 square feet, but you can use it exclusively for storing your business materials, computer, etc…and open it up and fold out a desktop to manage your business when needed. This type of strategy would close the door on the exclusive test, and open the door to a better auto deduction and more.
2. Principal Place of Your Business.
This has actually become the easier of the 2-part test to satisfy. In year’s past this was a more serious qualification, because if you had ‘another office’ in town for your business, your home office was generally off-limits. This was because your ‘principal’ place of doing business was the ‘other’ office. However, 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. The big breakthru for taxpayers however was in the Commissioner v Soliman case.
Dr. Soliman blazed the trail
In 1991 the IRS took on Dr. Soliman, an anesthesiologist, and disallowed his home office deduction. In 1993, the Supreme Court sided with the IRS and agreed that Dr. Soliman didn’t meet the Principal Place of Business Test. Although the anesthesiologist used a room in his home exclusively to perform administrative and management activities for his profession (i.e., he spent two or three hours a day in his home office on bookkeeping, correspondence, reading medical journals, and communicating with surgeons, patients, and insurance companies), the Supreme Court upheld the IRS position that the “principal place of business” for the taxpayer was not the home office, because the taxpayer performed the “essence of the professional service” at the hospitals. So what’s the big deal?!
In response to this terrible case, Congress passed the Taxpayer Relief Act of 1997 (effective 1999) and passed new legislation in regards to the Home Office Deduction. During the process, the House Ways and Means Committee explained that a home office qualifies as the “principal place of business” if the office is
- used by the taxpayer to conduct administrative or management activities of a trade or business[,] and
- there is no other fixed location of the trade or business where the taxpayer conducts substantial administrative or management activities of the trade or business.
Thus, the ‘Administrative office’ has evolved to give many, many taxpayers the option to meet clients/customers at a ‘main office’, but then comes home to return email, billing, do the books, and various other administrative tasks.
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 Home Office 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 the recordkeeping 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 sell 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, 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 of 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.
Don’t try and get sneaky
You may be thinking all of these business deductions are a waste of time and “I’ll just claim this money ‘under the table’. Not a good idea. Not only could you get busted by the IRS, but you also WANT to claim the income to increase your overall financial picture.
This extra ‘net’ income on your tax return could possibly fund retirement accounts, qualify you for a mortgage to buy a home, or even better terms on your current mortgage…and don’t forget: More tax write-offs!
The bottom line, having a small business allows you to better build AND live the American Dream. Moreover, the home-office deduction is just a small part of the overall equation. Talk with your CPA and demand an aggressive position on this deduction. Don’t be talked out of NOT 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 Podcast “Main Street Business Podcast” and author of the new book “The Tax and Legal Playbook- Game Changing Solutions For Your Small Business Questions, 2nd Edition”. the “8 Steps to Start and Grow Your Business Workbook”, and “The Business Owner’s Guide to Financial Freedom- What Wall Street isn’t Telling You”. He is also a senior partner at the law firm Kyler Kohler Ostermiller & Sorensen, LLP, and the accounting firm K&E CPAs, LLP.