Claiming the Home Office Deduction on Your Tax Return
TABLE OF CONTENTS
- What is the Home Office Deduction?
- Requirements for Claiming the Home Office Tax Deduction
- Deductible Expenses under the Home Office Tax Deduction
- How to Compute the Home Office Deduction
- How to Claim the Home Office Deduction on Your Tax Return
- How to Document Company Reimbursements for Home Office Expenses with an Accountable Plan
- Home Office Deduction Worksheet
- Documentation Requirements for the Home Office Deduction
The Home Office Deduction allows you to convert what would otherwise be personal, non-deductible expenses into tax deductions. The deduction is even more important in the new work-from-home environment as we shift away from having commercial offices. It is particularly helpful for those of us who live in large cities and pay significant amounts of rent each month (like yours truly). If you have a home office, you can deduct a portion of your monthly rent on your tax return. Homeowners can also get a deduction for a portion of their home’s value.
Read below for an overview of the Home Office Deduction. You will also find some helpful resources for making sure that you maximize the amount of deduction you can claim each year, including a spreadsheet to help you compute your Home Office Tax Deduction.
There are a lot of strategies you can use to maximize your Home Office Deduction. Don’t make the mistake of just relying on your CPA. I have seen a number of tax returns where the CPA failed to account for valid expenses or didn’t compute the deduction in a way that maximizes the amount you claim on your return. Some CPAs are even scared of the deduction. (See more on the myth that the Home Office Deduction increases your audit risk below.)
The structure of your business or investments will also impact how your deduction is calculated and claimed on the tax return. See below for an overview of how the Home Office Deduction should be computed for each of the different tax structures.
What is the Home Office Deduction?
The Home Office Deduction allows taxpayers to claim a tax deduction for certain expenses that are incurred in connection with maintaining an office in their home. A home for these purposes can include a condo or apartment. Freestanding structures such as barns and garages may also qualify. The deduction is available regardless of whether you rent or own your home.
The deduction may also apply to a place used solely for storage. If you use part of your home for storage of inventory or other business items, you may be able to deduct expenses even if that space is not used exclusively for business storage.
There are some requirements that you must satisfy before you can claim the deduction. The IRS provides two methods for computing the amount of the deduction that you may claim which we discuss in more detail below.
You will also be required to maintain proper documentation to substantiate the deduction. We have provided some helpful tips on how to make sure you keep adequate records in the unfortunate event you ever get questioned by the IRS.
Requirements for Claiming the Home Office Tax Deduction
There are two main requirements for claiming the Home Office Deduction:
Regular and exclusive use
The area of your home designated as your home office must be regularly and exclusively used for conducting business. As a general rule, you cannot use the same area for other non-business purposes. That means if you have a home office that you use 75% of the time to do business work and 25% of the time to watch football games, the entire space will be disqualified.
It is okay if you use the space for personal reasons as long as that use is de minimis. For example, a space can still qualify as exclusively used for business purposes even if you have to walk through that area to get to somewhere else in your home.
The most common example of an area that is regularly and exclusively used for your business would be if you have a separate room in your home or apartment that is treated as an office. However, it is not necessary that the room be separate from the rest of the home. For example, you could have an area in a room with a desk that you use for your home office that also has other space used for non-business purposes. You will only include the area in the room where you desk is located in computing the size of your home office.
What is critical is that the space you are claiming as a home office, no matter how large or small that space is or where it sits in your house, must be only used for business purposes.
You must also regularly use the space for business purposes. If you only work 1 hour every few weeks on something and never otherwise use the space for your business, it is unlikely that you will qualify. Rather you should spend at least a few days a week working from the space on a continuous basis throughout the year.
Principal place of business
The home office must be your principal place of business. That means that your office in your home must be the main place where you conduct your business affairs. It should also be the place where you handle the most important aspects of your business. You cannot claim the Home Office Deduction if you have a separate office space outside your home where you spend more of your working time.
However, it is not required that your home office be your only place of business. If you maintain a separate office outside your home, you may still be eligible for the deduction provided you use the home office substantially and regularly to conduct your business.
Can I Claim the Deduction if I am an Employee?
The good news is that if your company reimburses you for expenses that are incurred in connection with your employment, those reimbursements will not represent taxable income to you provided they are reasonable.
Will Taking the Home Office Deduction Increase My Risk of Getting Audited?
Moreover, who cares? The IRS has clearly sanctioned this deduction and even has a special form to use for claiming it on the tax return. If you aren’t convinced and want to do more reading yourself, checkout IRS Publication 587 (2021): Business Use of Your Home.
In addition, you should be able to easily substantiate the expenses deducted on your tax return if you maintain adequate documentation. Don’t let silly tales and fear keep you from claiming a valid, and potentially very sizable, tax deduction to which you are clearly entitled.
Deductible Expenses Under the Home Office Tax Deduction
Examples of common types of expenses that are deductible under the Home Office Tax Deduction are:
- Rent or depreciation (if you own your home)
- Mortgage interest
- Property or real estate taxes
- Utilities (gas, water, electricity)
- Alarms or security systems
- Garbage or recycling disposal services
- Internet and cable costs
- Cleaning fees
- Mileage for use of your car (see below for more discussion on how the Home Office Deduction can allow you to significantly increase the mileage deduction for business use of your personal car)
- Repairs and maintenance costs
- Renovations or capital improvements to the home
This is not meant to be an exhaustive list of all the types of expenses that may be claimed. If the cost is reasonably associated with your home office, you may be able to claim it on the return.
Make sure you don’t deduct the same expense twice on your personal tax return or your business’s tax return. For example, if you already deducted your telephone expense elsewhere on your return or your business’s return, you are not permitted to include those expenses again under the Home Office Deduction.
Special Considerations for Depreciation Deductions
There are some special considerations for some of the types of expenses that you may claim under the deduction. If you own your home and claim a depreciation deduction with your Home Office Deduction, you will be required to recapture that depreciation when you ultimately sell the home. That means that any depreciation you claim under the Home Office Deduction turns into taxable gain when you sell the home.
The current maximum tax rate that applies to depreciation recapture is 25%. That means you are still probably better off claiming the depreciation deductions even though you have to pay tax on the recapture amount when you ultimately sell the home. You may also avoid any recapture if you never sell the home and instead pass it down to your heirs through your estate.
CAUTION: TRAP FOR THE UNWARY
If you use the Actual Method (which is almost always the more preferable method), you will still be required to recapture the depreciation even if you didn’t claim it. So make sure you claim it on your return!
Be careful if you switch between methods for computing the deduction. Special rules apply for purposes of tracking depreciation deductions if you switch between using the Actual Method and Simplified Method.
I often see accountants advise their clients to not claim depreciation deductions because of the recapture requirement. This is bad advice for two reasons:
1. The depreciation recapture applies regardless of whether you claimed the deduction if you use the Actual Method (which means you lose the benefit from the current deduction but still pay the tax cost on the backend when you sell the home).
2. Depreciation recapture is usually taxed at a lower rate (25%). That means you likely still benefit from claiming the deduction at a higher marginal rate than you will have to pay when you sell the home several years later.
With that said, if you plan to sell your home in a few years, perhaps the time required to compute the depreciation deductions may not be worth the tax savings.
Special Consideration for Freestanding Offices
When you sell a property that you lived in as your personal residence, you may be able to avoid tax on all or a portion of the gain under the Home Sale Exclusion. This exclusion allows you to exclude up to $250,000 ($500,000 if you file a joint return with your spouse) of the gain from tax. There are special requirements that apply in order to be eligible for the exclusion, including certain minimum requirements for time spent living in the home.
If your home office space is in a separate structure that is not attached to the portion of your home where your living quarters are, you will be required to do a special allocation when you sell your home. The gain from the sale must be allocated between the building where your living quarters are located and the building where the home office is. The portion allocated to the freestanding home office in this case is not eligible for exclusion under the Home Sale Exclusion.
This issue is not relevant if your home office is within the same building as your personal residence.
CAUTION: TRAP FOR THE UNWARY
The Home Sale Exclusion is not available for freestanding home offices.
Allocating Mortgage Interest
The amount claimed under the Home Office Deduction and the amount reported on Schedule A should equal the total amount paid for the year. You are not allowed to claim the same amount twice on the return.
Taxpayers will receive no tax benefit for mortgage interest paid on your home if you claim the standard deduction instead of itemizing your deductions. With the SALT deduction currently limited to only $10,000, the number of taxpayers claiming the standard deduction is much higher than it used to be. The Home Office Deduction can help you convert a portion of that mortgage interest into a tax deduction that would have otherwise provided no benefit.
Mileage for Business Use of Your Car
However, if your principal place of business is your home office, as is required to claim a Home Office Deduction, then any time you drive your car for business purposes will be deductible. This can drastically increase the amount of mileage that is considered for business use by converting what would have otherwise been nondeductible commuting miles into business miles.
If you use the standard method for deducting mileage, the IRS sets an amount that you get to deduct for each mile you drive for business purposes. For the 2021 tax year, the standard mileage deduction is 56 cents per mile. That means if you drive 2,000 miles for business purposes in a year, your mileage deduction will be $1,120 ($0.56 x 2,000). The standard mileage deduction increases to 58.5 cents per mile for 2022.
There is an alternative method available to compute the deduction where you compute the deduction based on actual expenses. You should generally try to compute the deduction under both methods and claim the higher of the two.
Make sure you always document your mileage that is for business purposes. There are good apps such as MileIQ or TripLog that can help you easily track when you are using the car for business purposes.
Keep in mind that this only applies to mileage when you drive your car for business purposes. Any personal use of the car is never deductible.
This would not apply in situations where the business is the owner of the car. So if you previously transferred your car to your business, (which is always a great tax planning strategy where feasible), you are not allowed to also deduct the mileage for use of the car.
How to Compute the Home Office Deduction
There are 2 methods for computing the amount of your Home Office Deduction. Taxpayers are free to choose either method. However, for practical purposes, the Actual Method will almost always result in a higher tax benefit.
Under the Actual Method, taxpayers determine the amount of the deduction by computing the actual expenses related to their home office. This is done by dividing expenses between direct and indirect expenses.
Direct Expenses: Direct expenses are expenses that are solely related to the home office. Examples include a landline telephone that is only available and used in your home office. Direct expenses are deductible in full.
Indirect Expenses: Indirect expenses are expenses that relate to the home as a whole and are not specifically related to the home office. Examples include utilities, property taxes, or mortgage interest. Indirect expenses must be apportioned. Most of your expenses will likely be indirect expenses.
Indirect expenses are apportioned based on the percentage of your home office as compared to your entire home. The percentage may be determined by computing the proportion of the square footage of the home office to the total square footage of the home.
So if your home is 3,000 square feet in total and your home office is 600 square feet, your applicable percentage will be 20% (600 sq ft/3,000 sq ft).
Once you have your applicable percentage, you multiply your indirect expenses by that percentage to compute the amount of indirect expenses deductible.
The Simplified Method is not based on actual expenses attributable to your home office. Under the Simplified Method, the deduction is computed using a prescribed rate by the IRS. Currently, the rate is $5 per square foot up to a maximum of 300 square feet.
If your home is 200 square feet in total, your Home Office Deduction is $1,000 ($5 x 200). Because the total square feet is limited to 300 feet, the total Home Office Tax Deduction available using the Simplified Method is $1,500 ($5 x 300 sq ft) regardless of the size of your office space. Chances are high that if your home is larger than 300 square feet you are better off using the Actual Method.
How to Claim the Home Office Deduction on Your Tax Return
The way in which you will report the deduction depends on the type of structure you have. See below for the guidelines for computing the deduction for S Corporations, Partnerships, C Corporations, and LLCs with a single owner and no tax election in effect.
- Home Office Tax Deduction for LLCs with a Single Owner (not treated as an S Corporation or C Corporation)
Business owners, self-employed individuals, and freelancers can claim the Home Office Deduction by filing Form 8829: Expenses for Business Use of Your Home. The amount of the deduction will be reported on Line 30 of Schedule C with your individual tax return.
If your business is structured as a partnership, S Corporation, or C Corporation, see below for special reporting requirements.
- Home Office Tax Deduction for Partners in a Partnership
If the partnership reimburses its partners for the home office expenses, the partnership would take the deduction on the partnership’s tax return, Form 1065: U.S. Return of Partnership Income. This deduction will reduce the income allocable to the partners on their K-1s.
If the expense is not reimbursed by the partnership, partners may report the Home Office Deduction on Schedule E as an unreimbursed partner expense. Form 8829 does not need to be filed with the return.
However, an important point to note is that unreimbursed expenses are only deductible on the partner’s tax return if the partnership agreement does not provide for reimbursement of these types of expenses. Therefore, the partnership may need to amend its operating agreement in order to expressly state that the partners are required to pay these expenses personally.
CAUTION: TRAP FOR THE UNWARY
- Home Office Tax Deduction for S Corporation Shareholders
S Corporations need an accountable plan in place to maximize the Home Office Tax Deduction available. Failure to have a proper accountable plan in place may also result in owners having additional taxable income inclusions.
There are two ways S Corporation owners can claim the Home Office Deduction.
- Have Business Pay You Rent (no accountable plan in place): The S Corporation can pay owners rent for the home office space. In this case, the S Corporation will deduct rent paid to you on the S Corporation tax return. However, the S Corporation shareholder will have to include the rent paid by the business as income on Schedule E. This eliminates some of the benefit of the deduction. Also, any expenses reimbursed to owners that are not under an accountable plan may be includible in taxable income of the shareholders.
- Accountable Plan for Expense Reimbursements: S Corporations can have an “accountable plan for expense reimbursements” in place in order to claim expenses under the Home Office Deduction. The business will reimburse the owners for the home office expenses and claim the deduction for these expenses on the S Corporation tax return.
The accountable plan approach provides the most tax savings because there is no requirement to include the rental income or other reimbursements paid to you from the business in income on your personal return. There are special requirements in place for accountable plans so make sure you work with a competent advisor to put one in place for your business.
If an accountable plan is in place, owners will be reimbursed for expenses related to their home offices and the deduction will be claimed on the Form 1120-S: U.S. Income Tax Return for an S Corporation.
Make sure you have the business also reimburse owners for home office depreciation if the shareholders are homeowners under your accountable plan!
CAUTION: TRAP FOR THE UNWARY
- Home Office Tax Deduction for Owners of a C Corporation
If you have a C Corporation, including LLCs that elect to be taxed as C Corporations, you are not technically eligible to claim a Home Office Deduction. However, these expenses can be reimbursed by the C Corporation if you have proper documentation in place. In that case, the C Corporation would claim a tax deduction for the reimbursed expenses on the corporate tax return, Form 1120: U.S. Corporation Income Tax Return.
Similar to S Corporations, C Corporation owners can effectively claim a Home Office Deduction in the same two ways. Either the business can rent your home office from the owner and pay the owner rent or the company can reimburse the owner through an accountable plan for expense reimbursements.
As discussed above, having an accountable plan for expense reimbursements is the better option because the owner is not required to report the income as taxable income on Schedule E of their individual tax return.
Don’t forget to have the business also reimburse owners for home office depreciation if the shareholders are homeowners under your accountable plan!
How to Document Company Reimbursements for Home Office Expenses with an Accountable Plan
If your company is going to reimburse owners for home office expenses, or any business expenses for that matter, there are a few guidelines to follow in establishing your company’s accountable plan for expense reimbursements.
Document the Policy
The expense policy should be documented in writing. This is often done through what is called an “accountable plan for expense reimbursements.” Here is a sample accountable plan template for employee expense reimbursements you can use in preparing your own written policy.
Expense Reimbursement Sheet
The company should have a standard expense reimbursement sheet that it uses for all situations in which employees seek reimbursement for expenses from the company. Each expense reimbursement sheet should require the owner to provide receipts with the report. Owners will use this form to get reimbursement from the company for home office expenses.
Actually Move the Money
The money must move between the bank accounts. That means the company should physically pay the money from its bank account to the owner’s bank account as reimbursement.
Timing of Substantiation for Expenses
In some cases, there are time limits on how quickly the company must receive documentation from the employee in support of an expense eligible for reimbursement. In order to make sure you satisfy these timing requirements, it is best practice to have expense forms submitted and reimbursed on a monthly basis. That means there should never be more than 60 days before documentation is provided by an employee for an expense. This also applies for reimbursements for home office expenses. Best practice would be to get in the habit of doing this every month.
Keep Records of Receipts on File
There should always be a record of receipts documenting the expenses. You should keep these on file for at least 3 years. See below for details on the documentation requirements for the Home Office Deduction.
You can access our sample template for an accountable plan for employee expense reimbursements here.
Home Office Deduction Worksheet
Feel free to adjust the file however you see fit to adapt it to your own personal situation.
Documentation Requirements for the Home Office Deduction
Taxpayers planning to claim a Home Office Tax Deduction on their return should maintain good documentation to substantiate the home office expenses. This should include at a minimum the following:
- Receipts for all expenses
- Mileage log records for business use of your car
- Copies of how you calculate the percentage of expenses that are deductible if you use the Actual Method
- Written accountable plan for expense reimbursements, if relevant to your business
If your company has an accountable plan in place, make sure you require owners to attach receipts to any expense reimbursement sheets.
You should keep the documentation for each tax year where the tax return is still open for potential audit. This is generally 3 years from the date you filed the return.