Unraveling the Home Office Deduction
With tax paperwork filling our mailboxes this month and April not that far on the horizon, taxes are fresh on the mind of most Americans, including ways to limit and reduce tax liability.
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The good news is that if you are a business owner or employee with a home office, you may be able to deduct qualifying expenses. Although the rules regarding qualification are clear, many forego the deduction because they are unsure if they meet the criteria. There is even some concern that taking the deduction may trigger an audit from the IRS. To provide clients, prospects and others with the clarity they need regarding the home office deduction and when it can be claimed, Hanson & Co. has provided a summary below.
Determining the Deduction
The IRS offers two methods for calculating a home office deduction, including:
- Simplified Method – As the name indicates, this is a straightforward method for computing the business use of a home. While the standard method can involve calculating, verifying and substantiating a number of expenses and other variables, this method permits taxpayers to multiply a prescribed rate by allowable square footage. This makes it much easier to arrive at a deductible amount in lieu of determining actual expenses, although it generally leaves money on the table.
- Traditional Method – This method requires the taxpayer to calculate the actual expenses related to their home office. Expenses may include mortgage interest, insurance, utilities, repairs related to the home office space and depreciation. When using this method, deductions for home office are based on the portion of the home used for business. Because of this, the deduction will vary depending on how much space is used. This is clearly the more complex and involved method, so it’s generally used when projected expenses exceed those calculated under the simplified method.
The IRS allows both business owners and individual employees to claim the home office deduction. However, it’s important to note that individual employees have to meet additional criteria in order to realize a tax benefit. Below is a listing of the qualification criteria for both groups.
Business Owner Qualification
- Regular and Exclusive Use – The home office must be used regularly for the sole purpose of conducting business. For example, if a taxpayer runs a business from a dedicated space such as a spare room or other space not used for another purpose, then they may deduct qualifying expenses.
- Principal Business Location – The home office must be the principal place of business for the company. This doesn’t mean that it is the only place where business is conducted but that a majority of the business activities occur in the home office. For example, if business is conducted outside the home, but the home office is regularly and substantially used, then it’s likely the taxpayer will qualify for the deduction. It’s important to note that separate or free-standing structures such as garages and studios can also qualify for the deduction assuming they are used regularly and exclusively for business purposes.
Individual Employee Qualification
Unfortunately, having a home office because it is appropriate and helpful to you personally does not permit you to deduct home office expenses. In addition to meeting the criteria outlined above, an individual employee’s home office must:
- Be used for the convenience of the employer
- Not be leased to the employer and then used by the individual employee to provide services to the same employer
It can be difficult to determine which method to use when claiming the home office deduction and what expenses actually qualify. While the simplified option makes it easy to determine the benefit in certain circumstances, additional tax benefits can be realized when using the traditional method. If you have questions about the home office deduction, Hanson & Co. wants to help. For additional information, please call us at (303) 388-1010 or click here to contact us.