The Home Office Deduction for Small Businesses

4 MIN READ

With an ever-growing focus on work/life balance, more and more workers are making the transition from working in the office to working from home. In this new age of the virtual workspace, employers and clients alike have fewer expectations for a traditional office setting.

High speed residential internet, advanced technology, and countless apps have eased the transition from a traditional office setting to an office within your home. You can host meetings via your computer, share your screen with clients and attend live events…virtually!

But you don’t pay rent to yourself for your home office space, so what is the best way to correctly get these indirect expenses on your books?

There are two different methods the IRS allows for home office deductions: The Simplified Method and the Regular Method. We’ll cover both below.

Requirements 

First, let’s go over the requirements you must meet to deduct your home office on your taxes, regardless of which method you choose: 

1. The office has to be used exclusively and regularly for business, and
2. It must be the principal place of your business.

"Exclusively and regularly for business" means you can’t have a desk in your bedroom and call it an office. Your son or daughter can’t run a daycare business in the same room as your office. Your office has to be a completely separate room or portioned off section of a room where you exclusively conduct business. The room must also be regularly used. If you use it once a month, that likely doesn’t qualify as regular use.

The “principal place of your business” requirement needs a bit more clarification. Here, the IRS says you must show that you use your home as your principal place of business. That seems easy enough.

But what if you rent an office in town in addition to your home office? Are you no longer eligible for the home office deduction? Luckily the IRS has provided clarification here, stating that if you conduct business outside of your home office, but also use your home office substantially and regularly, you may be eligible for the home office deduction. 

The takeaway here is that if you have a home office and use it regularly to conduct business, then you can claim the home office deduction. 

However, if you are an employee of a business and have a home office that you use regularly and exclusively, you are no longer eligible to deduct your home office expenses as of 2018 under the new Tax Cuts and Jobs Act (TCJA). The TCJA eliminates miscellaneous itemized deductions subject to the 2% AGI floor. Tough love! 

The Simplified Method 

As aforementioned, there are two methods by which to deduct your home office. Let’s look at the Simplified Method first.

The name for this method is quite fitting; it’s simple. All you need to do is get out your tape measure and measure the length & width of the room. Multiply the two together and you have your office’s square footage. 

For every square foot of office space, you are eligible to take a $5 deduction, up to a maximum of $1500 or 300 square feet. You must have income in your business to take the deduction, and any losses generated from taking the home office deduction will not be carried forward to any other periods. All of your mortgage interest and property tax expenses can still be claimed on Schedule A itemized deductions. We will cover why this is important later.

The Regular Method

For the Regular Method you have to keep track of indirect and direct home expenses. New lighting and a new desk chair are examples of direct expenses. Indirect expenses include utilities, mortgage interest and taxes, insurance, and repairs.

Once you have all of these expenses summarized, take a seat because you need to enter all of that information in its respective place on Form 8829 to determine your home office deduction. Be sure to enter the value of your home because depreciation can be a large part of your deduction. 

Like the Simple Method, the Regular Method is only eligible to the extent to which your business has income, but unlike the Simple Method, you can carry over the unused portion to the next year and use it, so long as you have income in the following year. 

There are a couple caveats here:

1. Any depreciation taken must be recaptured as a gain when and if you sell your home
2. Any portion of mortgage interest and taxes that you claim on your home office deduction cannot be claimed on Schedule A itemized deductions

Which Method Should You Choose?

There really is no correct answer here except to look at your whole tax situation—not just the bottom dollar. Certain itemized deductions for higher earners get limited. If your property tax deduction on Schedule A is limited, you will reap more of a benefit using the Regular Method. Remember when using the Regular Method, the portion you claim as an expense for your business can’t be claimed as an itemized deduction.

Let’s say you are barely able to make the requirement to itemize deductions this year with the increased standard deduction, even though you have itemized in years past. Using the simplified method will maximize the amount of mortgage interest and taxes on your Schedule A. 

Finally, let’s assume you aren’t so great at record keeping and can’t be bothered with the time needed to accurately and correctly do the regular method. Without a doubt, the Simplified Method is for you. 

Still not feeling totally sure if you are eligible for the home office deduction, or have questions about which method you should choose? Then reach out! We’d be happy to discuss!

Click here to contact the Bean Team!