What You Need to Know About Home Office Deduction
Working from home? Here’s what you need to understand about the details of the Home Office Deduction.
Home office deductions have evolved, with Tax Cuts and Jobs Act (TCJA) disqualifying employees from claiming them, but self-employed individuals can still benefit.
A qualified home office must be regularly and exclusively used for business, while size impacts the deductible amount, and various exceptions apply.
Deductions cover both direct and indirect expenses related to your home office, with two methods available: the simplified method and the actual method, depending on your specific situation.
According to a recent PwC survey, 98% of employers (in the office setting) have shifted a significant chunk of their employees to remote work. And 89% expect it to stay that way even once the pandemic has officially “ended.”
So, there’s a good chance that you’re reading this blog post next to a hot cup of joe and a laptop in your comfy home office. But can you deduct that laptop on your taxes?
Home office deductions have been a de facto component of the work-from-home strategy for years.
In the past, when freelancers purchase a new webcam, computer, or printer paper, they could deduct those purchases on their annual taxes. And they still can. But you probably can’t.
The Tax Cuts and Jobs Act — a massive tax code law signed in 2018 — prevents those who work at home for an employer from deducting out-of-pocket expenses. Of course, this is the tax code we’re talking about. Whether you consider the tax code to be 2,400 pages or 70,000 pages by technicality, there’s one thing that remains abundantly clear: things are never simple in the world of taxes.
So, let’s discuss how home office deductions work in 2020. Let’s get to the nitty-gritty details of our wild, wonderful, and often confusing American tax code.
Who Can Claim Home Office Deductions?
The Tax Cuts and Jobs Act (TCJA) effectively disqualifies employees from claiming home office deductions. There’s some solid reasoning behind this.
For starters, the TCJA also bumped standard deductions across the board. For example, your standard deduction jumped from $6,350 to $12,000 if you file as Single or Married Filed Separately.
Additionally, freelancers have an increased tax debt compared to traditional employees.
Employed individuals have their FICA taxes (i.e., FICA and Medicare) taxes split between them and their employer. Self-employed individuals have to pay the full amount.
The home office deduction is meant to provide the self-employed with tax credits that are normally afforded to qualified businesses — since they are effectively paying the full tax burden.
If you’re self-employed, the TCJA doesn’t change your ability to file home office deductions. You can still claim home office deductions (using either the simplified method or actual expenses) to lower your gross income.
Key points:
Employees cannot claim a home office deduction
Self-employed individuals can still claim a home office deduction
The Tax Cuts and Jobs Act increased standard deductions, which is considered to “make up” for this change in tax code for employees
What is a “Home Office”?
A home office is an area that is “regularly and exclusively” used as a place of business or a place to meet and interact with clients. In other words, your home office needs to be a space specifically for work.
Obviously, incidental use isn’t going to automatically disqualify you from deducting the space, but it should be an area that is dedicated to business.
To be clear, a home office does not have to be a room with four walls. It can be an area in your living room or part of your bedroom.
There aren’t specific requirements in terms of size or location — though size impacts that amount you can deduct from taxes.
Your home office must also be your “principal place of business.” So, if you work from multiple locations, the IRS may challenge your deduction.
There are plenty of caveats to this definition, so let’s cover a few:
In-home daycare businesses do not have to meet the “regularly and exclusively” component of the home office definition. However, they must meet two requirements:
The business must provide daycare for children, people over 65, or those with disabilities
The business must be accredited and licensed by the state to provide daycare services
The “principal place of business” rule also applies to offices used exclusively for administration and management. So, if you work as a self-employed individual for multiple businesses with an office in each area, you may be able to deduct each office location so long as you are using them for administrative or management purposes
If you claim a home office deduction, the depreciation for that space can’t be claimed on your taxes when you sell your home. This can get complex, and there are certainly ways to gain that appreciation back when you sell. So, you should consult your tax professional during this process
When you sell your home, using the actual-method of home office deductions could theoretically force you to pay a capital gains tax
You can claim a separate deduction for any areas where you store business goods (e.g., basement, garage, shed, etc.) This deduction does not require that area to be exclusively used for business, but it does require you to meet additional guidelines (see IRS Publication 587)
Key points:
A home office is an area that is used regularly and exclusively for business within your home
A home office is your principal place of business
Deducting Home Office Expenses
In addition to deducting the square-footage of your home office, you can deduct both direct (e.g., furniture, supplies, etc.) and indirect expenses (e.g., utilities, insurance, etc.) related to your office. For direct expenses, you can deduct the entirety of the expense so long as the expense was directly related to work.
For indirect expenses, you can deduct a portion of the expenses based on the size of your office.
Example: You have a 2,000 square-foot home with a 200-square foot home office that you use regularly and exclusively for the sole purpose of your freelance business. This year, you purchased supplies ($300), a new chair ($200), a computer ($800), and a speaker ($150).
In addition, you paid for electric ($3,000), internet ($1,500), and home insurance ($1,300) for your entire home.
You could deduct the supplies ($300), chair ($200), computer ($800) and speaker ($150) outright. You could also deduct 10% (2,000/200) of your electric ($300), internet ($150), and home insurance ($130).
Your total deductions (excluding square-footage) would be $2,030.
Direct expenses may include:
Furniture
Maintenance
Equipment
Home office supplies
Computers
Cameras
Speakers
etc.
Indirect expenses may include:
Internet service
Electric
Home security fees
Home repairs (to the outside)
etc.
Remember, this does not include square-footage deductions, which are based on your mortgage/rent and the type of deduction you choose.
Key points:
You can deduct direct office expenses like supplies, furniture, and equipment
You can deduct a percentage of indirect home expenses (e.g., utilities, security, etc.) based on the square footage of your office compared to your total square footage
The Simplified Method vs. The Actual Method of Home Office Deduction
There are two ways to take a home office deduction:
Simplified Method: For many, calculating the barrage of direct and indirect expenses for their home office is a hassle-filled affair. Not only do you have to keep receipts and logs, but you have to make plenty of calculations when it comes to things like utilities and insurance. The IRS provides a simplified method that allows you to take a simple $5 per-square-foot deduction on your home office space.
Actual Method: With the actual method, you will calculate your overall costs — including utility and mortgage ratios — for your home office space. While this method is often more tedious, it can result in higher overall returns.
Choosing the right method is entirely situational. In some scenarios, using the simplified method will actually net you a higher deduction.
However, in many scenarios, the actual method is superior — though it requires you to train as a record-keeping guru.
Important: the simplified method has a $1,500 maximum cap. If you believe that your home office exceeds that limit, it’s always better to choose the actual method.
Key points:
The simplified method allows you to take a flat $5 per square foot (up to $1,500) in deductions for your home office
The actual method involves calculating your exact deduction based on space, utilities, rent/mortgage, supplies, and more
If you use the actual method, you need to keep receipts and practice good record-keeping
Don’t Fear the Tax Code
Every year, billions of dollars get unclaimed during tax time, and billions more are lost due to poor tax filing. America has a long-standing fear of the IRS and the auditing process.
Nerd Wallet surveys suggest around 70% of Americans get worried during tax time. Don’t let that worry prevent you from taking advantage of the proper tax breaks.
Sure! You can’t file a home office deduction if you’re an employee that’s all-aboard the COVID-19-induced remote work train. But you have plenty of other tax break options at your fingertips.
For those that are self-employed, make sure you calculate your home office deduction correctly - don’t leave thousands of dollars on the table.
