Taxpayers sometimes prefer to avoid deductions that are “audit red flags.” While we agree, an audit is no fun, fear of an audit is no reason to avoid taking a home office deduction if you legitimately qualify for one.
In recent years, the IRS has made it easier to calculate a home office deduction, allowing you to choose to use the safe harbor method or the regular actual expenses method for any taxable year. By working closely with an accountant or tax adviser, you should be able to determine the best method for documenting your expenses and stay within the rules to qualify for the deduction.
A home office deduction has specific rules that must be met. First, it has to be your principal place of business. If you’re self-employed, it must be where you regularly perform your administrative or management activities, or meet with clients or patients. Secondly, you must be able to show you use your home office exclusively for business on a regular basis. This means the home office cannot also be your music room where you jam on your guitar on the weekends. The rules are very particular. For example, if you partition the room to include both a music room and a home office, only the home office portion of the room would be deductible. If your business involves selling a product, generally you can take a home office deduction for the area used to store your inventory.
If you are an employee who works from home or your job requires you to telecommute, you too may qualify for a home office deduction. The IRS requirements are the same: the space must still be your principal place of business and it must be exclusively used for business. However, your home office must also be for the convenience of your employer, i.e., your employer must ask you to work out of your home.
Self-employed taxpayers claim the home office deduction on IRS form 8829, Expenses for Business Use of Your Home, when reporting income from their business on Schedule C, Profit or Loss from Business. If you are an employee, the home office deduction is taken as a miscellaneous itemized deduction on Schedule A of IRS Form 1040. Furthermore, this deduction is subject to the 2% limit for miscellaneous itemized deductions.
What exactly can you deduct? Depending on the method you use to calculate your deduction, you can deduct direct and indirect expenses including deductible mortgage interest, real estate taxes, rent if you do not own the home you live in, utilities including gas, electricity and trash removal, homeowners or renters insurance, any direct phone lines installed exclusively for the business, repairs to your home, casualty losses, security systems and depreciation.
Not only will you benefit from a tax adviser’s help when calculating your deduction, you may also want their help when you sell the home. Generally homeowners can exclude up to $250,000 in capital gains from the sale of their primary residence from federal income tax ($500,000 for married filing jointly). If you have taken depreciation on your home office, you may end up paying some taxes on the gain when you sell the home. The taxable amount will be considered unrecaptured Section 1250 gain, which is taxed at a rate of 25%.
Overall, deductions help taxpayers minimize their tax obligations. The IRS has stringent rules to dissuade those who don’t qualify from taking deductions they shouldn’t. If you have a legitimate home office, consider working closely with your tax adviser to ensure you take the deductions you are entitled to. If you have questions on your home office deduction, the experts at Henssler Financial will be glad to help:
- Experts Request Form
- Email: experts@henssler.com
- Phone: 770-429-9166.
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