Who qualifies for the home office deduction?

You qualify if you use a specific area of your home regularly and exclusively for business and meet rules for self-employment or employer requirements; employees face stricter limits.

How do you calculate the home office deduction?

Calculate using the simplified method (a fixed rate times office square footage) or the actual expense method (business-use percentage applied to eligible home expenses and depreciation).

Home Office Deduction: Calculating and Claiming It

A how-to for figuring out if you are eligible, claiming deductions and not running afoul of the I.R.S., which has been flooded with questions.

The idea of working from home has gained traction among numerous professionals and small-business owners. If you use part of your home for business and that portion is used regularly and exclusively for that purpose, a home office deduction may be available. This guide introduces you to who qualifies, how you can calculate the deduction if you have two methods at your disposal, which records to keep and how to claim what’s yours without running into problems down the road.

Who qualifies for the deduction

In order to claim the deduction, you must use a certain space in your home regularly and exclusively for business. Daily use is when the space constitutes an active place of business and it's used in a businesslike manner, continuously. Exclusive use refers to the space being used exclusively for business — a spare bedroom used as an office only, for example, works; a kitchen table that is also used for family meals and work does not.

This deduction is usually taken by self-employed individuals, independent contractors and freelancers. Workers who work from home could only be covered in limited situations that take into account the type of work they perform and their employer’s direction — if they are not reimbursed, meaning it is required by their employer, for a remote workspace. Be sure to verify eligibility per the current tax rules that apply to you.

Two Ways to Determine the Deduction

There are two methods of deducting home office expenses: the simplified method and the actual expense method. It has rewards in each context, depending of course upon your own situation.

1) Simplified method

Under the “streamlined” method, the deduction would be calculated by multiplying an applicable rate (based on use) by the square footage of eligible space. This is simple, multiply the square footage or the proportionate size of a room used exclusively for business times the allowable amount per square foot and that’s your deduction. It's simple to use and helps you eliminate the painstaking process of keeping detailed expense records. But it could result in a lower deduction than the actual expense method for those with higher costs related to their home.

Example: If your office is 150 square feet and the rate is a fixed dollar amount per square foot, then you multiply to get the deduction. It’s appealing in its simplicity if you don’t want to keep much of a record or do the math.

2) Actual expense method

Under the actual expense method, you must determine the percentage of home expenses allocable to the business-use area. Begin by calculating the percentage use of your home for business: Take square footage of office and divide it by total finished square footage of entire home. Multiply that percentage by eligible expenses including mortgage interest, rent, utilities, homeowners insurance, property taxes and depreciation. Share of certain bills deductible in full, others prorated.

Direct costs (such as painting or repairing in office) are 100% deductible. An allocation of indirect costs (e.g., gas, electricity, mortgage interest) is deductible according to business use. Depreciation of the home is significant for homeowners under the actual expense method, and can boost long-term tax savings.

Which method should you choose?

If you prefer simplicity and certainty and have modest home-related costs, go with the simplified method. Opt for the actual expense method if you have large deductible home expenses and are diligent in documenting them. Some choose to calculate both ways in the first year they qualify, and take whatever option provides a larger deduction, while others opt for whichever method works best with their records and tax scenario.

Recordkeeping and documentation

Keeping good records is how you protect yourself in an audit, and it also helps you take the right deduction. Maintain documentation that includes:

A chart or floor plan indicating office square footage and total home square footage.
Receipts and bills for household expenses, including utilities, insurance, mortgage interest or rent, repairs and improvements.
A business use log if the space is not used every day. Keep in mind, though that any personal use beyond the de minimis threshold discussed earlier can threaten exclusivity, so tread carefully.
List of how you figured percentages, depreciation schedules if using the actual expense method.

How to report and claim the deduction

Taxpayers who are self-employed typically report the deduction on the tax form for business income and attach a schedule providing details of expenses. The simplified method usually entails a simplified entry, whereas the actual cost approach calls for more detailed reporting of information, particularly as it pertains to depreciation. If you are an employee who wants the deduction, be aware of the current rules that restrict this opportunity — many employees expenses are no longer deductible unless certain conditions apply.

Common pitfalls to avoid

Personal use in combination with business: If the defined office has any personal use, even casual use, exclusive-use test is not met.
Bad measurement: Inaccurate measurements of square footage can result in errors. Take dimensions for interior walls and finished areas only.
Ignoring local rules and limits: There are caps and limits for some deductions, and tax laws may vary by locality. Keep in mind annual maximums for simplified rates and depreciation recapture rules when selling the home.
Ignoring the effects of depreciation: Depreciation taken against the portion of your home used for business will factor in when determining gain or loss on a sale – and may result in recapture.

Strategies to maximize and safeguard your deduction

Keep detailed, contemporaneous records of all costs and the business use of your space.
Adjust your business-use percentage when you remodel or shift the way you use your home.
Think about the tax and non-tax implications of taking depreciation. You might be subject to recapture rules on sale, if you take depreciation.
If your circumstances include complex ownership structures and multiple taxpayers who claim the same home, or mixed-use spaces, talk to a tax professional or trusted guidance sources.

In summary

The home office deduction may be a valuable source of tax savings for those who qualify, but it depends on clear eligibility, accurate math and strong record keeping. Ultimately, you’ll choose between the simplified and actual expense methods based on how much your expenses are and whether or not you’re in the mood to keep a lot of records. Keep good records, measure your space precisely and be aware of the depreciation implications for your business in the long term. You can take the deduction with confidence and lower your taxable business income if you prepare correctly.