It’s not only real estate agents and investors that frequently work from home. According to the latest numbers from the Bureau of Labor Statistics, 24% of employed people now do some or all of their work at home. If you're eligible, a home office deduction can save you big bucks at tax time. Your home office expenses can be deducted if you are a homeowner or renter and applies to all types of homes. You can also deduct expenses for a separate freestanding structure, such as a studio, garage, or barn, if you use it exclusively and regularly for your business.
It is slightly more complicated if you work from home for a company other your own. For instance, you still qualify if you represent a corporation that doesn’t have an office (or space for you) in your city. The key here is that it has to be for the convenience of the employing business. Not because you simply prefer working from home. The slight complication is the IRS may require you to provide a letter from your employer stating this arrangement is for their convenience. And you certainly can’t double dip by renting your home space to your employer and then deducting it on your taxes.
You must meet two basic requirements to claim the home office deduction. First, an area of the home has to be designated as your principal place of business. Second, it must be used exclusively for work. That means a spare bedroom that your mother-in-law occasionally stays in or sitting on your couch with a laptop doesn’t qualify. However, it doesn’t have to be a separate room. If your desk is parked in a corner of your bedroom or part of an open floor plan, simply measure the space you use for your office, whether or not there are walls.
A principal and exclusive place of business doesn’t mean it’s the only place you can conduct business. You can still do what other business people do by going out for business lunches, showing real estate to clients, and other related activities. The key is the deducted area must be used only for work. Not for you or your kids to play video games on the computer.
Since tax year 2013, there have been two ways you can calculate your home business expenses. The newer method (starting tax year 2013) is much simpler and quicker to calculate. You can claim your deduction by figuring out the square footage of the space in your home that you use for business purposes. Each square foot you use for work is worth $5 and you can claim up to 300 square feet for a maximum claim of $1,500. Simple and straight forward. Measure the square footage of space you use exclusively for work, multiply it by $5 to arrive at your deduction as long as it doesn’t exceed $1,500. Of course, always look up the current year tax code to be sure the maximum square footage and dollar amount haven’t changed.
The older version is much more complicated and must still be used if you want to claim more than $1,500 in deductions. The IRS offers a home office deduction worksheet to figure things out. Calculating this involves tracking all the costs of your home (including: insurance, repairs, utilities, property taxes, etc.) and depreciation (normal wear and tear). Starting with the total expenses for your home, you then separate and allocate those expenses based on the percentage of the home you use solely for business purposes. That means if your office space breaks down to 10% of your home’s total square footage, you can deduct 10% of your home costs - which can add up to a sizable chunk of change. The key to using this deduction is keeping careful records.
Some homebased business people fear this deduction because they think it’s a red flag for an IRS audit. Certainly, you should be taking every deduction you’re entitled to. Reality is that this is a valid deduction that tempts many people to fudge the numbers. Take the full deduction but the wise taxpayer will be sure he or she can verify all of the expenses - just in case.
Please leave your suggestions for maximizing home business tax deductions or if you have a question. Also, our weekly Ask Brian column welcomes questions from readers of all experience levels with residential real estate. Please email your questions, inquiries, or article ideas to [email protected].