Since the pandemic started, more and more people have begun to work from home. Some work remotely for an employer; others freelance or own a business. That makes your home also your place of work. Does that mean it’s tax deductible? The answer is, it depends. For one thing, you can only use the home office tax deduction if you work for yourself. For another, you have to be very careful to deduct only the expenses involved in your home office, not those for the entire house.
The Home Office Deduction
The IRS allows a tax deduction for a home office. But not everyone qualifies, due to some important caveats.
First, you can’t claim this deduction for remote work you do for an employer. Since 2018, the home office deduction only applies to self-employed workers. However, if you work both for an employer and for yourself, you can still claim the home office deduction. You must have some Schedule C income from self-employment to qualify. If you freelanced some months of the year and worked for an employer the rest, you can only claim the home office deduction for months when you freelanced.
Second, you must have an area of your house that you regularly and exclusively use for work. If you work from your dinner table, you can’t take the deduction. But if you work in a variety of locations, such as on-site, and have one area in your home where you do the necessary administrative work, you can. It simply has to count as your primary place of work.
Your home office doesn’t have to be a whole dedicated room. It could be a desk in a corner of the den, in which case you’d consider the desk and the area around it where you sit a “home office.”
How to Calculate the Deduction
You have two options for calculating the deduction: standard or simplified. The standard method involves calculating all your actual expenses for your office. You calculate what percentage of your home your office is. For instance, if you have a 200-square-foot office and a 2000-square-foot home, your office is ten percent of your house.
Next, calculate how much you pay for the house as a whole in mortgage, insurance, utilities, and whole-house repairs like a heater repair. The total cost of your office in the above example would be ten percent of those total home costs. Then you can add on any office-exclusive expenses, such as furnishings or paint only for the office.
The simplified deduction usually comes out to less money, but you spend less effort calculating it. Just take the square footage of your office, up to 300 square feet, and deduct $5 per square foot.
Either way, you will prorate this amount if you worked from home only part of the year. For instance, if you worked from home for six months, you divide your total deduction amount by two before claiming it.
If you take the standard deduction, you calculate it using Form 8829 and submit that form with your tax return. If you take the simplified deduction, you simply enter it on Schedule C. Either way, your home office deduction can’t equal more than you earned in self-employment income.
Is It a Home, or an Office?
A home office lies in an awkward halfway zone between a home and an office, each of which has different tax benefits.
A home you live in is exempt from capital gains tax when you sell it, up to certain limits. In the past, the tax code required you to pay capital gains on the office portion of your home when you sold it. Now, this requirement has been removed if the office is in the same building as your home. It still applies if the home office is in another building on the property, like a shed or detached garage.
An office, on the other hand, has its own tax advantages. As a commercial property, it’s eligible for a deduction on depreciation. You can deduct a percentage of an office’s value every year to account for wear and tear. This is also true of a home office. To determine the annual depreciation of a home office, first calculate the percentage it takes up in your house in order to determine the home office’s value. Next, divide that value by 39 (the useful life of an office) to find the amount your home office depreciates annually. This amount can be part of your home office expenses if you use the standard method.
But any time you deduct or could deduct depreciation, you become subject to depreciation recapture. This means that when you sell the property, you will have to pay a tax equivalent to 25% of the total depreciation deductions you’ve taken or could have taken while living there.
Sound complicated? If your home office is small, it may make more sense just to take the simplified deduction. In that case, you won’t take a depreciation deduction and won’t have to pay depreciation recapture. The total amount of deductions is usually less, but you’ll skip out on the complication of the standard method.
Should You Take the Home Office Deduction?
Before deciding to set up your home office or take a deduction for it, you should consult a trusted financial advisor. They can help you work out whether it actually saves you any money to itemize by the standard method, and how to keep proper records in case of an audit. To connect with a skilled financial advisor, contact us today!