Home office tax deductions: Your checklist of do's and don'ts
We know, we know: You've been stuck inside for a solid year, in one corner of your kids' now-unused bedroom, adjusting the pro lighting you bought for Zoom sessions, debating the virtue of the new desk chair you bought. You're glad you sprang for three monitors, not just one, but you still think you should have bought a faster PC.
You spent all year becoming a home office perfectionist, and here comes your payoff. It's tax time, and that means it's time to add up all the ways you spent to build your home office and get something back for it.
The following checklist covers the essentials of itemizing deductions for your home office. Even if you use some slick tax software package, or even if you've got a great accountant, it's worth a few minutes to think about the most crucial checklist items before you engage with either of those processes.
Also: The best tax software for businesses or personal preparation
Who qualifies? Not employees!
Let's get one very important thing out of the way: You cannot, repeat, cannot deduct the cost of using your home if you are an employee.
It's right there in the instructions for Form 8829 of the Internal Revenue Service, "Expenses for Business Use of Your Home": "You cannot claim expenses for business use of your home as an employee."
Why not?It seems almost a cruel joke, but the 2017 Tax Cuts and Jobs Act, passed long before most people expected a pandemic, removed the use of miscellaneous itemized deductions, which was the instrument by which individuals could typically claim unreimbursed work expenses as an employee, including the use of the home.
With millions of people now working for their employer out of the den or a spare bedroom after the kids have gone to college, it would be nice if employees could use that miscellaneous deduction. But such is not the case. (However, some states, including New York and California, will let taxpayers claim home expenses when they file.)
The elimination of miscellaneous itemized deductions is supposed to be temporary, expiring in 2026. But some would like to make it permanent. Texas senator Ted Cruz last month introduced a bill to make permanent the elimination of miscellaneous itemized deductions while raising the limit of the standard deduction.
Exclusive and principal are the watch words
Be that as it may, for those of you who are business owners or freelancers, keep in mind a key phrase about home offices: Exclusive and principal. The place in your home that is your home office doesn't have to be permanently separated by walls, but that patch of space has to be only used for your business. Your desk in your bedroom probably doesn't count, nor your dining room table.
And the section of your home that is exclusively a workspace must also be the main workspace for the administration of your business, known as your principal place of business. That means there is no other fixed location where you conduct the main administrative tasks of your business.
Exceptions to these rules are for meeting clients and for free-standing structures. If you are a doctor, say, and you have an office away from your home, but you also regularly meet patients at home, that space in your home set aside for patients can qualify. Also if you have a separate structure on your property, such as a freestanding studio building, that qualifies.
Three easy pieces
For small business owners and self-employed, think about your home office in three simple steps.
Personal expenses, such as mortgage interest and real estate taxes come first, if you are itemizing those deductions rather than taking the standard deduction. After those come the business expenses that are not the business use of the home, such as cable service, computers, and cellular service costs.
After all that is done, you can then move on to deducting business use of the home, including depreciation of your home, and deduction of portions of rent. The reason to do it this way is that how much of your home expense you can deduct is based on your gross proceeds minus those personal deductions and minus your other business expenses. So you need to think about all your deductions before you think about deducting the home office itself.
Think broadly about business expenses
For the business expenses that are not the business use of your home, such as cable internet, think broadly. Cable is obvious. The business portion of your fixed line and your cellular costs are deductible, based on a percentage of use that is business-related. Supplies that are incidental, such as pens and paper and printer toner cartridges count as office expenses.
Of course keep in mind your advertising expenses, of all kinds, from direct response ads to Twitter ads. And legal fees of all sorts are obvious things to put on your list.
If your business occupation is of the information kind, such as freelance writing or consulting, consider all the books, journal articles, and periodical subscriptions relevant to your trade as items that can be deducted as materials. They're piling up over there in the corner, and they're part of your cost of doing business.
You may have whole new classes of materials that are suddenly a part of your business world, such as your Zoom video needs. Did you buy a green screen or even a role of green paper for backgrounds? Pro lighting? Consider throwing that in as an office expense.
Speaking of Zoom, many home businesses will increasingly make use of a number of subscription services. That may include a Zoom Pro subscription, Skype or Microsoft Teams. Monthly charges for web hosting, domain name maintenance, email service from a dedicated hosting party, etc., are all good examples.
If you subscribe to news wire services or financial information services such as FactSet, these can be a fairly big operating expense that you should also look to deduct.
You might be surprised to learn that some consumer-esque services can be deducted. If using Netflix or Apple Music actually figures as an element in your interactions with business guests in your home, say, to entertain them, you may be able to make a case for deducting the cost of those as well.
And of course, though it's outside the home, don't forget to keep a log of your travel expenses to deduct.
Everything but the kitchen sink
Next, you move on to the big stuff, what's called Section 179 property, such as a car. Starting with 2020, you can deduct up to a million dollars in total for Section 179 property. Individual vehicles have specific deduction limits. For example, a sports-utility vehicle has an annual deductible limit of $25,900.
Section 179 surprisingly includes intangibles such as computer software that is generally available on the market and that you acquire expressly for the purpose of using it in your business.
Interestingly, memberships you pay for can also count as Section 179 property, if they pertain to running your business. They're counted as what are called created intangibles.
More information on the do's and don'ts of Section 179 can be found in Publication 946. The eBook version is very nicely done, and well worth downloading to your preferred eBook reader.
The other big category of stuff around your home office is what's called five-year and seven-year property. This is a very broad set of stuff you may acquire that exists within the class of real property, and it includes computers, including laptops and tablets, and peripherals, and other technology, and office furniture.
The numbers refer to the period over which these items are depreciated. (In case you were wondering, vessels including barges and tugs are 15-year property, but that probably won't concern you at your home office.)
The main difference between Section 179 and other stuff like computers is how you deduct it. Section 179 is generally deducted in the year you bought it up to the dollar limit, which, as mentioned above, is a limit of $1 million annually. Items such as computers and furniture and other business items such as a safe you install at home for your valuables are depreciated by a set schedule over the number of years for that kind of item.
For example, a $2,000 computer will be depreciated by having 40% of its value available to be deducted in the first year of ownership, then 40% of the remaining value in year two, etc.
Don't sweat the math. You likely will not be doing it yourself. Your tax preparer, or a software program, will do that for you. It's just to give you a sense of how things work.
However, what you should do is with each of these home business expenses, keep a written record that lists, at a minimum, how much you paid for the item, the date when you acquired it, and for what business purpose you acquired it.
To the extent possible, it's not a bad idea to account for the amount by which you used the piece of property for business, such as miles driven in the case of a car.
Once you've tallied up all your obvious direct or indirect home expenses, there's yet another way to possibly score as a home business: Credits. Things such as buying an electric vehicle yield special credits for their use. The IRS's Publication 334 is a good place to start looking at the selection of credits for which you may be eligible.
Remote work
An office of one's own
This brings us to the final piece, claiming the actual square footage of your den, spare bedroom, or some corner you've blocked off for exclusive and principal use.
You can measure your home office space in two ways, precise or simplified.
In the first method, you divide the area used at home by the total square footage of your home, and the resulting percentage is how much you multiply all the direct expenses of maintaining that home office, including maintenance, such as repairs to your home, insurance, and the cost of utilities such as gas and electric. If you're a renter, it means the portion of your rent you can deduct, equal to your rent multiplied by that percentage.
For homeowners, one can also depreciate the value of the home. This involves figuring out the cost basis of your home, which is its own adjustment, and then taking a small fraction of that value for each year, starting with the year you put the home into service for your business.
Again, this will be calculated for you, most likely, but if you're interested in the details, it is contained in the same Publication 946 that covers depreciation of Section 179 property.
If you'd like to avoid all that complexity, the second approach is what's called the simplified method. In this approach, you simply multiply the smaller of the square footage of your home office or 300 square feet by 5, and that's the total dollar amount you can deduct. If the situation changes over the year -- you moved into a home office mid-way through the year-- you take a simple average of the monthly square footage and use that.
Whether you choose precise expenses, including depreciation, or you go with the simple method, all of this will end up on Schedule C of form 1040 if you're a freelancer or sole proprietor, and on one of the other schedules if you're a partner in a business. The main difference between the two approaches is that with real expenses, an extra form gets filled out, form 8829, "Expenses for business use of your home," along with the expenses mentioned above such as computers.
All of the details of either the complex method or the simple method can be found in Publication 587, "Business use of your home."
Remember the three-step rule: How much you can deduct in the square footage of your home will be limited by how much you have already deducted for mortgage interest and real estate taxes, and how much you've deducted for those other business expenses.
There's one more caveat: You can only deduct the expense of your home office from the revenue actually generated by your home. Even if you meet the exclusive and principal criterion, if you generated some portion of your revenue from another location, that portion of revenue is not factored among your gross income from which you deduct your home office expenses.
Hopefully, all of this clarifies the mechanics for you. It may also make you thankful you have either an accountant or some piece of tax software to handle the details!
Useful references:
- Publication 587, Business use of your home
- Publication 946, How to Depreciate Property, eBook edition
- Form 8829, Expenses for Business Use of Your Home
- Publication 334, Tax Guide for Small Business (For Individuals Who Use Schedule C)