Home Office Deductions
August 19, 2014
With the increase in telecommuting, many more of our clients are now working remotely, spending substantial amounts of time working in an office physically located in their home or perhaps in a separate structure located on their property. As this situation is becoming more common, we would like to discuss the home office expense deduction. You may work out of your home as a business owner or as an employee. However, in order to take a deduction for home office expenses, the home office must qualify as such under strict rules governing the deduction.
The home office must meet one or more of the tests described below to qualify as such. The common theme running through these tests is that the space designated as a home office be used exclusively and on a regular basis for business.
Principal place of business. You are entitled to home office deductions if you use your home office exclusively and on a regular basis as your principal place of business. Your home office is your principal place of business if it satisfies either a "management or administrative activities" test or a "relative importance" test. You satisfy the management or administrative activities test if you use your home office for administrative or management activities of your business. You meet the relative importance test if your home office is the most important place where you conduct your business, in comparison with all the other locations where you conduct that business.
Place for meeting patients, clients, or customers. You are entitled to home office deductions if you use your home office exclusively and on a regular basis to meet or deal with patients, clients, or customers. The patients, clients or customers must be physically present in the home office.
Separate structures. You are entitled to home office deductions for a home office used exclusively and on a regular basis for business that is located in a separate unattached structure (such as unattached garage, workshop, or studio) on the same property as your home.
Space for storing inventory or product samples. If you are in the business of selling products at retail or wholesale, and if your home is your sole fixed business location, you can deduct home expenses allocable to space that you use regularly (but not necessarily exclusively) to store inventory or product samples.
Exclusive and regular use requirements. As noted above, the home office must be used exclusively and on a regular basis in connection with your business or work as an employee. The exclusive use requirement means that you must use your home office solely for the purpose of carrying on your business or work. Any other use of the home office will result in loss of all deductions for your home office expenses.
For example, if you work in a spare bedroom that contains your desk, computer, fax, files, etc., and if you don't use that bedroom for anything but your work, that room passes the exclusive use test. However, if you also use the room to accommodate occasional overnight guests, it fails the exclusive use requirement. If you use the room exclusively for work during your regular workday, but the room reverts to other uses at nights and/or on weekends, it also fails the exclusive use test.
The regular basis requirement means that you must use the home office in carrying on your business on a continuous, ongoing or recurring basis. Generally, this means a few hours a week, every week. A few days a month, every month, may also pass this test, but once-in-a-while business will not meet this requirement.
Convenience of the employer requirement. If you are an employee, you must also satisfy the “convenience of the employer” requirement. This requirement is satisfied if:
1. you maintain your home office as a condition of employment. In other words, your employer specifically requires you to maintain the home office and work there;
2. your home office is necessary for the functioning of your employer's business; or
3. your home office is necessary to allow you to perform your duties as an employee properly.
The convenience of the employer requirement means that you must maintain your home office for your employer's convenience, and not for your own. This requirement is not satisfied if your use of a home office is merely "appropriate and helpful" in doing your job.
Types of expenses. If you meet the requirements discussed above, you can deduct the expenses associated with the home office. There are "direct” expenses such as the costs of painting or repairing the home office, depreciation deductions for furniture and fixtures used in the home office. You can also allocate and deduct "indirect" expenses of maintaining the home office. These are shares of utility costs, depreciation, insurance, rent, mortgage interest, and real estate taxes. Please note that home telephone expenses are not considered allocable indirect home office expenses. Telephone expenses directly associated with the business or work (such as long distance call cost) are allowed as a business deduction, separate from the home office deductions.
Limitations on deductions. The amount you may deduct as home office expenses is subject to limitations based on the income attributable to your use of the home office. Any home office expenses that cannot be deducted because of the limitations may be carried over and deducted in later years.
If you are an employee, your home office deductions are reported on Schedule A of your income tax return. These are deductible only to the extent that they, together with all your other miscellaneous itemized deductions, exceed 2% of your adjusted gross income. The tax benefit of these deductions may further be limited by the alternative minimum tax regime.
For this reason, and the effect of home office deductions on the later sale of your home (discussed below), it may not be worthwhile to take these deductions as an employee.
Effect of home office deductions on later sale of your principal residence. If you claim a home office deduction, any gain attributable to the depreciation deductions will not be eligible for the otherwise available $250,000/$500,000 exclusion for gain on the sale of principal residence. Also, the exclusion won't apply to the portion of your gain allocable to a home office that is separate from the dwelling unit.
Simplified Option. For taxable years starting on or after January 1, 2013, there is a simplified option for computing the business use of your home. This new 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. You still must meet the requirements discussed above.
Home-related itemized deductions (mortgage interest and property tax) may be claimed in full on Schedule A. The home office deduction is $5 per square foot (not to exceed 300 square feet). The deduction is limited to the net income from the business use of home. Unused amounts cannot be carried over. There is no depreciation and thus no recapture upon sale of home.
We hope this discussion is helpful to you in determining whether or not you have a home office that qualifies for the home office deduction. Should you have any questions, please contact us.