The home office deduction: Rules, who qualifies, and how to calculate
8 min read
February 15, 2024 • Block Advisors
One of the biggest values of being your own boss is deciding where you want to work. With a growing number of small business owners working from home, many wonder if they qualify for a home office deduction. Like many other small business tax deductions, a home office tax deduction comes with rules and best practices. Read on to learn more about the qualifications, the simplified calculation method, and more about work from home tax deductions for small businesses.
Who can take a small business home office tax deduction?
The small business home office deduction applies to taxpayers who use part of their home exclusively and regularly for trade or business purposes.
Here’s the catch: you must use the space as a main place of business, like where you meet with clients or customers during the course of a business day. The exclusive-use work area also must be an identifiable space and not be combined with personal-use space (such as the family room). Let’s learn more about how to take a small business home office tax deduction.
Who qualifies for a work from home tax write-off?
To qualify to claim expenses for business use of your home, you must meet both of the following tests:
- The part of the home must be:
- Exclusively and regularly used for a trade or business (special rules apply to space used as an in-home daycare facility) or
- Used for storage of inventory or product samples; AND
- The business part of the home must be one of the following:
- The principal place of business;
- A place where the taxpayer meets or deals with patients, clients, or customers in the normal course of a trade or business or significant and essential to the conduct of the business; or
- A separate structure (not attached to the home) is used in connection with the trade or business.
If you use space in your home to provide daycare, you might be able to claim a deduction for that part of your home even if you use the same space for nonbusiness purposes if you meet both of the following:
- You are in the trade or business of providing daycare for children, persons age 65 or older, or persons who are physically or mentally unable to care for themselves, AND
- You have applied for, been granted, or are exempt from having a license, certification, registration, or approval as a daycare center or as a family or group daycare home under state law (you do not meet this requirement if your application was rejected or your license or other authorization was revoked).
And if you think you don’t qualify as a renter…think again. Homeowners and renters are both eligible for a home office tax deduction.
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Why is the IRS home office deduction valuable?
The home office deduction is a potentially valuable self-employed tax deduction for individuals looking for ways to reduce the taxable income of their small business.
How do you calculate the home office write-off?
The home office deduction can be calculated in two ways: the regular method or the safe harbor method (simplified method). Don’t want to tackle figuring out either method alone? Get help with your small business taxes from the team at Block Advisors.
Home office regular deduction method
This method involves totaling the direct and indirect expenses of your home office for deduction purposes. Expenses can include:
- Mortgage interest payments
- Real estate tax
- Dwelling insurance
- General repairs
Direct expenses are only for the business use of your home, such as painting and repairing your office. Indirect expenses are for keeping up and running your entire home. Deductions using the regular method are based on the percentage of your home devoted to business use. Whether you work out of an entire room or just part of one, you’ll need to determine the percentage of your home used for business.
Home office safe harbor deduction method
The home office safe harbor deduction is a simplified way to claim a home office deduction. This option does not change the criteria for who may claim a home office deduction.
If you use this simplified option, you can multiply the allowable square footage of your office by a rate of $5. The maximum footage allowed is 300 square feet, meaning the maximum deduction is $1,500. This option will save you time because it simplifies how you figure and claim the deduction. It will also make it easier for you to keep records.
Whatever method you use, your deduction shouldn’t be more than your gross income after you’ve subtracted your other business expenses (not related to your home). Under the regular method, any extra amount may be able to be carried forward to the next year (subject to gross income for that year), but under the safe harbor method, any extra amount can’t be carried over to a future year.
What will the IRS look for when taking a home office deduction?
The Internal Revenue Service (IRS) is interested in:
- Where your home office is located
- How you claimed the home office expenses over the years
Why the location of the home office matters
The IRS uses several factors to determine whether your home office is officially part of your personal residence. A Block Advisors tax professional can help you determine and answer this question because it will affect your tax return.
- If your home office is part of your personal residence, you’ll pay less (or possibly nothing) on the profits you make from your home sale. The profit you make from the home sale will be excluded from taxes (up to $250,000 for a single filer and $500,000 for married taxpayers filing jointly) for taxpayers who used the home as a personal residence for at least two of the five years before the home sale.
- If the home office is separate from your personal residence, you’ll have more work to do. In this case, you’d have to divide your profits between personal and home office sales. This process is called “allocating gains.” It means that you’ll owe taxes on the part of the sale attributed to your home office, but you won’t owe taxes (up to the limit) on the profit attributed to your personal residence.
Consider the yearly home office depreciation deduction
The deduction method you choose matters when it comes to the yearly home office depreciation deduction. Depreciation allows for your property’s decrease in value due to normal wear and tear. If you claim home office expenses using the actual expense method, you deduct depreciation if you have profit. Under the safe harbor method, you don’t.
- If you used the actual expense method to claim home office expenses, you’ll owe taxes on all the depreciation you’ve deducted or could have deducted if you had a profit. This is called “recapture of depreciation,” and you can’t exclude it from taxes.
- If you use the safe harbor method to claim home office expenses, you don’t deduct depreciation. So, you won’t owe taxes on any depreciation when you sell.
- Things get more complicated if you’ve switched methods from year to year. In that case, you’ll have to recapture depreciation for years you claim actual expenses, even if you use the safe harbor method at the sale. Switching between the safe harbor and actual expense methods requires special calculations of depreciation, so it’s a good idea to consult a tax and accounting advisor for help.
The method you use also affects your tax situation when you sell the home.
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Special instances: Moving
Thinking of moving? The home office deduction could get trickier. Consider the scenarios of these two self-employed people looking to sell their home (with a home office).
- Alan is a psychiatrist and has converted a room in his home into an office for meeting patients.
- Larry fixes small engines in a shed he built in the backyard of his home.
Do Alan and Larry get to exclude profits from the sale of their home on their taxes?
As for Alan, because his home office is part of his personal residence, he may qualify for the sale of home exclusion, and he doesn’t need to allocate gains between his personal residence and his home office.
As for Larry, because his home office is separate from his house, he needs to allocate his gain or loss between the residence portion and the business use portion, and the business use portion will be reported as a sale of business property.
Alan and Larry will both need to recapture any depreciation they claimed or could have claimed for years they used the actual expense method to claim home office expenses. If they deduct actual home office expenses, depreciation deductions reduce the adjusted basis of their home. If they use the simplified option, no basis adjustments are necessary.
We can help with the home office tax write off and more
A Block Advisors small business certified tax pro can help you determine which method may be best for you to claim home office expenses. When you sell your residence, your tax pro can help you determine whether you should exclude the gain and/or recapture depreciation.
We’re experienced in serving businesses like yours. Learn more about Block Advisors small business certified tax pros.