Do Your Kids Watch TV in Your Home Office?

Know the Rules to Understand If You Qualify for Deduction

Today, technology allows us the opportunity to work from just about anywhere. One benefit is the ability to work from home. This has brought the home-office deduction into play for some taxpayers — or so they think. Taxpayers assume that, since they work from home, they will qualify for the deduction. This may not be the case, as we will see in this article.

Tax law states that the deduction is permitted for expenses associated with that portion of the home that is exclusively used on a regular basis either (1) as the principal place of business for any trade or business of the taxpayer; (2) as a place of business that is used by patients, clients, or customers in meeting or dealing with the taxpayer in a normal course of his or her trade or business; or (3) in the case of a separate structure that is not attached to the home, in connection with the taxpayer’s trade or business. As long as one of the above requirements is met, the taxpayer can take the deduction.

A principal place of business is a location that a taxpayer uses for the administrative or management activities of the taxpayer’s trade or business if there is no other fixed location where the taxpayer conducts substantial administrative or management activities.

‘Exclusively used on a regular basis’ can be a difficult hurdle to overcome. A taxpayer must use the space exclusively for business all the time and not just during business hours. This means that the kids cannot go into the ‘office’ to watch TV or do their homework. It also means that the business owner who does his or her billing on the kitchen table does not have a space that is exclusively used in business.

The most likely scenario is that a self-employed business owner has an office in his or her home that they use for business. The billing, scheduling, administrative work, etc. is done in this room since the taxpayer has no other location to do these types of activities. The office is not used by anyone else in the household during off hours.

A note on employees: if you are an employee who works from home and has a home office, you can take the deduction as long as you are working from home for the convenience of the employer. Most employees work from home for their own convenience.

If it has been determined that there is a home office, what expenses are deductible, and how is the deduction calculated? Relevant expenses are categorized as direct and indirect. Direct expenses benefit the office portion of the home directly (e.g. painting the office) and are deducted in full. Indirect expenses are incurred while maintaining and operating the home. Indirect expenses must be allocated since they benefit both the home and the home office. The allocation is based on floor space of the office compared to that of the home in total to arrive at a business percentage. The indirect costs are multiplied by the home-office percentage to arrive at the total indirect cost.

The allowable home-office deduction cannot exceed the gross income from the business less all other business expenses attributable to the activity. Home-office expenses of a self-employed individual are trade or business expenses, and are deductible for adjusted gross income. Any disallowed home-office expenses are carried forward and used in future years, subject to the same limitations.

In January 2013, the IRS released guidelines that allow a taxpayer an optional ‘safe-harbor’ method to calculate the deduction. This optional method has been available since 2013. If the taxpayer elects this method, he or she can deduct $5 per square foot of office space in the home, up to a maximum of 300 square feet. The maximum amount of home-office deduction using the safe harbor is $1,500. The requirements discussed above must be met to deduct the safe-harbor amount. If the taxpayer is using the safe-harbor method, he or she cannot deduct the actual cost as well.

If the safe-harbor method is elected, no depreciation is allowed in that year. Taxpayers who itemize deductions can still deduct all costs that are normally deductible as an itemized deduction if the safe-harbor method is used. If you elect the safe-harbor method one year, you can switch the actual cost in the next year. There is no limitation on switching between methods year-to-year.

As you can see, potential exists to save some tax dollars if you use a portion of your home for business.

Sean Wandrei is a lecturer in taxation at the Isenberg School of Management at UMass Amherst. He also practices at a local CPA firm; [email protected]