Respect, But Don’t Fear, the Home Office Tax Deduction
Posted By Arthur Murray on November 8, 2016 at 3:39 pm
The rise of the “gig” economy means more people are working at home, enjoying freedom from restrictive office rules and the independence of being their own bosses. This is especially true for young people – more than a third of independent contractors are between the ages of 21 and 39, according to a 2016 survey. Many of those young people may not understand that in certain circumstances they can take a home office deduction when filing 2016 income tax returns.
First off, you don’t have to own a home to take the home office tax deduction, a good thing for millennials, many of whom put off buying houses because of student loan debt. Renters may take the deduction, too. And second, relax. Regardless of what you’ve heard, taking the home office deduction doesn’t automatically trigger an audit. That said, don’t take the home office deduction if you don’t qualify for it.
IRS rules for a home office
Following are the two major requirements for claiming a home office deduction, straight from the IRS:
- Regular and exclusive use. You must regularly use part of your home exclusively for conducting business. For example, if you use an extra room to run your business, you can take a home office deduction for that extra room.
- Principal place of your business. You must show that you use your home as your principal place of business. If you conduct business at a location outside of your home, but also use your home substantially and regularly to conduct business, you may qualify for a home office deduction. For example, if you have in-person meetings with … clients or customers in your home in the normal course of your business, even though you also carry on business at another location, you can deduct your expenses for the part of your home used exclusively and regularly for business.
What does that tax lingo mean? GoodCall asked some experts.
Don’t take the deduction for granted
Abby Eisenkraft, an accredited tax adviser and planner with New York-based Choice Tax Solutions Inc., explained the IRS rules. “Many people work at home, but it does not automatically guarantee the home office deduction,” she says. “The home office is defined as an exclusive area where the ONLY thing that transpires is work.”
The distinction can get complicated. “For example,” Eisenkraft says, “if you work in your bedroom and there’s a desk, there is no home office deduction because you fail the test – it is not a mutually exclusive area where you do your work – it’s also a place where you sleep. If you have a spare bedroom, and it’s solely an office (no guest bed, no laundry hanging up, etc.), then it passes the test.”
But she also explains that the home office doesn’t have to be separate: “It does not have to be a walled room; it can be part of the living room but an exclusive area for your work (and storage of business items too). It cannot be your dining room table on which you do all of your work, then wipe off the papers and put down your dinner plates; that will fail the test.”
Make sure your business is a business
When is a business not a business? When it’s a hobby. David Walters, a certified financial planner and CPA with Palisades Hudson Financial Group in Portland, OR, explains: “The line between a hobby and a business is sometimes blurry: If you sell a single knitted sweater on Etsy in a year, is that a business? How about 20 sweaters? As far as the IRS is concerned, the difference between a hobby and a business is profit motive.”
Among the ways to establish that profit motive, Walters says, is to treat the venture like a business. “Keep books and records clearly, and consider a dedicated bank account for your business activity,” he says. Otherwise, you might not be able to claim the deduction.
What’s at stake with home office tax deduction
If you think you have a legitimate home office that will pass IRS scrutiny, you can deduct a portion of your household expenses, such as your utilities, mortgage interest or rent, repairs, depreciation and more from your income. For example, if your home is 1,500 square feet and your designated home office is 150 square feet, you could deduct 10% of those expenses from your income.
That requires some extensive recordkeeping, of course. And believe it or not, the IRS has an easier alternative. It’s called the “simplified option” and allows you to multiply the square footage of your home office – up to a maximum of 300 square feet – by a rate of $5, with the result being the total home office tax deduction. It bears repeating that the eligibility test for a home office using the simplified option is no different than for the regular option.
But regardless of the option you use, you can reduce your tax liability substantially – if you’re eligible.
So should you claim the deduction?
As always, when it comes to federal tax returns, if you have any doubts, contact a professional before filing. You might spend a few more dollars upfront, but you could avoid real problems later.
That said, Walters doesn’t think people should avoid the deduction out of fear. “You should be careful to take your home office deduction correctly, but if you deserve it, don’t skip it simply because you’re afraid it might be complicated,” he says.
“There’s no need to leave money on the table when dealing with Uncle Sam.”