If you work from a home office, you may qualify for a tax deduction. For example, if you use 15% of your home as an office, you can write off up to 15% of your household bills like utilities, insurance, and general repairs. It is easy to qualify for the deduction, but you need to meet a few IRS requirements.
How to Qualify for the Home Office Tax Deduction
The IRS has established two tests that you must pass to qualify for the home office tax deduction. The first is called the “Regular and Exclusive Use” test, and the second is the “Principal Place of Business” test. You’ll need to pass both tests to qualify for the deduction.
1. Regular and Exclusive Use Test
To pass this test, you must regularly use part of your home exclusively for business. For example, if you have an extra room in your home set up as your office and that is the only thing that room is used for, then you have passed the Regular and Exclusive Use test. A specific area of your home that is not a separate room but is used exclusively for business also qualifies.
If you have a seasonal business—selling holiday gift baskets, for example—that operates from September through December, you are eligible to take this deduction for the four months in which you operate your business.
As with most IRS rules, there are a couple of exceptions. You do not have to pass this first test if either of the following applies:
- Part of your home is used to store inventory or product samples
- You use part of your home as a daycare facility
2. Principal Place of Business Test
To pass the requirements of this test, you must use your home office as your principal place of business, exclusively and regularly. You can have more than one place where you conduct business. However, to be eligible for the home office deduction, you need to conduct the majority of the administrative or management activities for your business at your home office.
The IRS considers the following items to be good examples of what they consider to be administrative or management activities:
- Invoicing customers
- Scheduling appointments
- Inventory and/or supply ordering
- Preparing reports
Home Office Deduction Example
Here is an example from IRS Publication 587 of a self-employed plumber who meets the requirements of the home office deduction:
John is a self-employed plumber. Most of John’s time is spent at customers’ homes and offices installing and repairing plumbing. He has a small office in his home that he uses exclusively and regularly for the administrative or management activities of his business, such as phoning customers, ordering supplies, and keeping his books.
John writes up estimates and records work completed at his customers’ premises. He does not conduct any substantial administrative or management activities at any fixed location other than his home office. John does not do his own billing. He uses a local bookkeeping service to bill his customers.
John’s home office qualifies as his principal place of business for deducting expenses for its use. He uses the home office for the administrative or managerial activities of his plumbing business, and he has no other fixed location where he conducts these administrative or managerial activities. His choice to have his billing done by another company does not disqualify his home office from being his principal place of business.
Types of Home Office Expenses You Can Deduct
Here are some examples of the home office expenses you can deduct:
- Repairs and maintenance to the area used for business
- Real estate taxes
- Home mortgage interest
You may be able to deduct some expenses from your taxes in full while others can only be partial deductions. The IRS breaks down deductibility by types of expenses: Direct, indirect, and unrelated.
Types of Expenses Eligible for Home Office Tax Deduction
|Direct||Expenses only for the business part of your home (e.g. repairs or improvements made to the space that you use for your office).||100% Deductible|
|Indirect||Expenses for keeping up your entire home (e.g. insurance, utilities, general repairs).||Deductible based on the percentage of your home used for business. For example, if my home office space is 10% of the total square feet of my home then I can deduct up to a maximum of 10% of indirect expenses.|
|Expenses for the areas of your home that are not used for business (e.g. lawn care, pool service, etc).|
Last update on 04/03/2020.
How to Compute the Home Office Tax Deduction
You have two choices when it comes to figuring out your deduction: the simplified method or the regular method. As the name implies, the simplified method is the easier route to go, but it’s only available if your expenses don’t exceed your income. Otherwise, you’ll have to use the regular method.
Simplified Method Home Office Tax Deduction
To calculate the home office deduction using the simplified method, you need the following information:
- The square footage of the area of your home that you use exclusively and regularly for business. This area cannot exceed 300 square feet. For tax purposes, this is called the allowable area.
- Your business’s gross annual income. You should be able to get this information from your profit and loss (P&L) statement for the current tax year.
- Your total annual business expenses not related to the use of your home. You wouldn’t consider rent, for example. You should be able to get your total expenses from your P&L statement for the current tax year.
Example Calculation Using the Simplified Method
Once you have computed the allowable area, your gross income, and total expenses, follow the steps below to calculate your home office deduction:
1. Multiply the allowable area (up to 300 square feet) by $5 (if you are a daycare, see IRS Publication 587 for special rules that apply). Let’s say, Rita, who operates an ecommerce business from her home, has an allowable area of 250 square feet. She would multiply 250 by $5.
250 x $5 = $1,250
2. Take your gross business income and subtract your total business expenses. If your total expenses exceed your gross income, then you are not eligible to take the home office deduction. According to Rita’s P&L statement, her gross income is $10,000, and her total expenses are $4,000. Calculate the difference between these two figures.
$10,000 – $4,000 = $6,000
3. If the difference between your gross income and total expenses is a positive number like we have in this example, then proceed to step 4. However, if your total expenses exceed your gross income, resulting in a negative number, then you do not qualify for a home office tax deduction.
4. Take the smaller of the results between steps 1 and 2. This is the amount you are allowed to deduct for your home office expenses. Rita’s answer in the first step was $1,250 while step 2 was $6,000. Because the smaller of these two results is the $1,250, Rita’s home office deduction is $1,250.
Actual Expenses Method Home Office Tax Deduction
If you do not meet the requirements to take the home office deduction using the simplified method because your expenses exceed your income, then you can use the actual expenses method to see if you qualify to take the home office tax deduction. While this method requires a bit more work to calculate, it could give you a larger deduction because it is based on actual expenses as opposed to just a formula based on the square footage of your office space.
For example, under the simplified method, a business owner who lives in New York City with a 200-square-foot home office and another business owner who lives in Boise, Idaho, with a 200 square foot home office would both end up with the same deduction, assuming that their gross income is more than $1,000:
200 x $5 = $1,000
Because it is much more expensive to live in New York City, it may work in that taxpayer’s favor to use the actual expenses method rather than the simplified method.
Example Calculation Using the Actual Expenses Method
1. Calculate the percentage of your home used exclusively and regularly for business. If you have a 2,000-square-foot home and your home office is 200 square feet, then the percentage of your home office space is 10%.
200 ÷ 2000 = 10%
2. Classify all expenses to determine their deductibility. The IRS has classified expenses into three categories: Direct, indirect, and unrelated. Use the table above to reference examples of each category for expenses.
Similar to the simplified method, if your gross income exceeds your total expenses, under the actual expenses method, you can deduct all of your direct expenses and indirect business expenses related to the use of your home office.
However, if your total business expenses exceed the gross income from your business, then your deduction for certain expenses for the business use of your home will be limited under the actual expenses method.
Home Office Deduction Form
Since the home office tax deduction is only available to self-employed businesses and single-member LLCs that file a Schedule C, you need to complete home office deduction Form 8829. Then, follow the instructions on the deduction form to transfer your deduction to the appropriate line on your Schedule C.
Home Office Deduction Form Documentation
You should keep any documentation you used to calculate your home office deduction. In case of an audit, keep these records on file for at least three years after the date that you filed your tax return. If possible, scan these documents to your computer for safekeeping.
Here are the key documents and information you should keep to support your home office tax deduction:
- Your taxpayer ID number
- Canceled checks or bank statements showing payments made
- Copies of bills like your mortgage and home insurance
- Receipts for any repairs or improvements made
- Square footage of the entire home
- Square footage used for your home office
Identifying qualifying business expenses and calculating your home office tax deduction can be complicated, but it doesn’t have to be. Trying to prepare your business taxes manually also leaves a large margin for error in calculation. You may find it easier and more efficient to use a small business accounting software package to help you keep track of your business expenses. Most software solutions allow easy reporting on tax-relevant information, making it easy to prepare your own taxes or send the pertinent information to your tax preparer.