Home Office Deduction of Space and Operating Expenses

IRS Taxes

Introduction

Whether you are self-employed or an employee, if you use a portion of your home for business, you may be able to take a home office deduction, including some operating expenses for the business use of a part of your home. These expenses may include mortgage interest, real estate taxes, insurance, utilities, repairs, and depreciation. If you are a homeowner or renter, the home office deduction is available and applies to all types of homes, from apartments to mobile homes. These calculations require a solid grasp of mathematics, and I recommend you retain the services of a qualified accounting professional in completing the IRS schedules and forms noted below. For starters, IRS Publication 587 will be your primary resource for understanding the particulars of deducting a portion of the cost of operating your home when you regularly and exclusively conduct a trade or business from there.

Six Rules Governing the Home Office Deduction

1. Generally, to claim a business deduction for your home, you must use part of your home exclusively and regularly:

  • as your principal place of business, or
  • as a place to meet or deal with patients, clients or customers in the normal course of your business, or
  • in any connection with your trade or business where the business part of your home is a separate structure not attached to your home.
  1. For certain storage use, rental use, or daycare-facility use, you are required to use the property regularly but not exclusively.
  2. Generally, the amount you can deduct depends on the percentage of your home used for business. Your deduction for certain expenses will be limited if your gross income from your business is less than your total business expenses.
  3. Special rules for qualified daycare providers and for persons storing business inventory or product samples requires careful analysis.
  4. If you are self-employed, use Form 8829, Expenses for Business Use of Your Home, to figure your home office deduction and report those deductions on line 30 of Form 1040 Schedule C, Profit or Loss From Business.
  5. If you are an employee, additional rules apply for claiming the home office deduction. You must meet the tests discussed above, plus:
    • Your business use must be for the convenience of your employer, and
    • You must not rent any part of your home to your employer and use the rented part to perform services as an employee for that employer.

Exclusive and Regular Use

The rules governing the home office deduction require you to use the area within your home in your trade or business on both an exclusive and regular basis. Importantly, you must meet both “tests” to qualify for the deduction. Failure to meet one even though you meet the other will deny you the opportunity for this deduction.

To qualify under the exclusive use test, you must use a specific area of your home only for your trade or business. The area used for business can be a room or other separately identifiable space. The test is easily met when you use a den or bedroom for your home office, opening and closing the door upon your visits to your desk. However, the area you claim to be your home office space does not need to be a room with a door; you can work from a larger area, such as a living room, great room or basement, provided you can make a compelling argument that the area is clearly designated as business use space only. Partitions are a great use in this regard, but you could conceivably hang curtains from the ceiling and get the same effect.

You do not meet the requirements of the exclusive use test if you use the area in question both for business and for personal purposes. Personal use of space or property claimed to be of a business nature almost always denies a taxpayer the benefits of deductions within the Internal Revenue Code (the “Code”). Personal use of alleged business property is a common theme throughout the Code for denying deductions and exemptions. See Note, below. To avoid this conundrum, you need to follow the exclusive use test for the home office deduction to the letter and spirit of the law. A clear differentiation in the books and records of the taxpayer on the portion of the property that has been used for business versus personal purposes is the best practice.

To qualify under the regular use test, you must use a specific area of your home for business on a regular basis. Incidental or occasional business use is not regular use. The IRS will use a “facts and circumstances” test in determining whether your use has been on a regular basis. Mere “profit-seeking activities,” such as reading financial newspapers or watching financial news television programs in an effort to make money by day-trading of securities, do not pass the test: your use of your home must be for a defined business or trade.

Thankfully, the same home office can be the principal place of business for two or more separate business activities and you can have more than one principal place of business for the same enterprise.

If you conduct business at a place outside of your home, but also use your home substantially and regularly to conduct business, you may qualify for the deduction. For example, if you have in-person meetings with patients, 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. You can deduct expenses for a separate free-standing structure, such as a studio, garage or barn, if you use it exclusively and regularly for your business. The structure does not have to be your principal place of business or the only place where you meet patients, clients or customers.

Furthermore, you can have more than one business place, including your home, for a single trade or business. To qualify to deduct the expenses for the business use of your home under the principal place of business test, your home must be your principal place of business for that trade or business. In reaching a conclusion, consider (1) the relative importance of the activities performed at each place where you conduct business and (2) the amount of time spent at each place where you conduct business. Your home office will qualify as your principal place of business if you (a) use it exclusively and regularly for administrative or management activities of your trade or business and (b) you have no other fixed location where you conduct substantial administrative or management activities of your trade or business. The fact that third-party vendors conduct administrative or management activities on your behalf from a different site will not deny you the designation of your home as your principal place of business.

How To Define the Deduction

Generally, deductions for a home office are based on the percentage of your home devoted to business use. So, if you use a whole room or part of a room for conducting your business, you need to figure out the percentage of your home devoted to your business activities by measuring the square footage of the area you use for business and dividing it against the total livable square footage of your home. The IRS states that you can use any reasonable method to determine the business percentage. Commonly used methods for figuring the percentage include these: (1) Divide the area (length multiplied by the width) used for business by the total area of your home or (2) If the rooms in your home are all about the same size, divide the number of rooms used for business by the total number of rooms in your home. Based upon these results, you will be able to deduct a percentage of all operating costs of the home against your gross business income and even depreciate that part of the real estate.

How Much of The Deduction Can You Claim

If part of the gross income from your trade or business is from the business use of part of your home and part is from a place other than your home, you must determine the part of your gross income from the business use of your home before you figure the deduction limit. In making this determination, consider the time you spend at each place, the business investment in each location, and any other relevant facts and circumstances.If your gross income from the business use of your home equals or exceeds your total business expenses (including depreciation), you can deduct all your business expenses related to the use of your home. If your gross income from the business use of your home is less than your total business expenses, your deduction for certain expenses for the business use of your home is limited.

Your deduction of otherwise nondeductible expenses, such as insurance, utilities, and depreciation (with depreciation taken last), that are allocable to the business, is limited to the gross income from the business use of your home minus the sum of the following.

  1. The business part of expenses you could deduct even if you did not use your home for business (such as mortgage interest, real estate taxes, and casualty and theft losses that are allowable as itemized deductions on Schedule A (Form 1040)).
  2. The business expenses that relate to the business activity in the home (such as, business phone, supplies, and depreciation on equipment), but not to the use of the home itself.

If you are self-employed, do not include in (2) above your deduction for half of your self-employment tax.

Conclusion

The ability to deduct the expenses associated with a home-based business or office against gross income is an important consideration for many small business owners, particularly since technology advancements make the need and even desire for a brick-and-mortar store front more and more less appealing. To properly claim this deduction, you should consult with a qualified accounting professional in completing the worksheets and forms required of you by the IRS. But in no case should you shy away from this opportunity simply because it seems complex, as the tax benefits are real and available.

Note:

For example, the IRS routinely denies deductions of alleged business use property involving personal use of , among other things, (i) company vehicles, computers and photocopiers (see, e.g., IRS Publication 535, Business Expenses) (ii) rental and/or investment property such as vacation and/or second homes, as in Moore v. Commissioner, T.C. Memo. 2007-134 and Goolsby v. Commissioner, T.C. Memo. 2010-64 or (iii) travel and lodging expenses where the personal benefits far outweigh the business purpose of the trip, as in Wright v. Commissioner, 31 T.C. 1264 (1959), aff’d. 274 F.2d 883 (6th Cir.1960). Even personal use of corporate aircraft is a thorny issue. See Non-Business Use of Employer-Provided Aircraft.