There are many Americans who work from home and the tax code allows for the deductions of some of the home office expenses. The IRS has guidelines to determine what qualifies as a home office and the type and extent of expenses that can be deducted. The IRS has recognized that many tax filers are generous with claiming home office deductions and as a result, these deductions draw an above average amount of scrutiny. Those wishing to claim home office deductions should be confident that their deductions meet the IRS’s criteria and be able to prove it.
The IRS wants you to know six things to test possible home expenses to see if they meet the threshold. The test to determine what constitutes a home office is multifold and varies depending on the type of business.
To claim a home office, it must be a section exclusively used for business regularly as the principle place of the business or as a place to meet or deal with customers. The tough part here is the word “exclusively.” That means the area cannot be used for any personal use such as paying bills, surfing the Internet or working on any non-business related activity. The office does not need to be a whole room or have its own entrance from the outside, but it must be a defined space that doesn’t co-mingle with personal space. The use for business regularly does not mean that 9-5 hours must be kept, as even part time use of the home office will qualify.
There are certain uses which do not need to meet the “exclusively used for business” criteria and these include certain storage use, rental use, or daycare-facility use. A daycare-facility, for example, is rarely limited to a section of a room or to a single room as it would be routine to use many sections of the home. Storing inventory in one’s basement does not mean that personal items now must be stored in the attic.
Now, claiming one’s entire home mortgage interest payment will surely grab the IRS’s attention. This is because the IRS only allows for a percentage of the home expenses to be deducted based on the percentage area that the business occupies of the home. For example, if a home office is 100 square feet in a 2,000 square feet home, only five percent of the electric bill or heating bill can be deducted as a qualifying deduction.
If the home office expenses are larger than the business income, there are some restrictions on certain deductions. This prevents the home business from carrying over large business losses from year to year as a result of home office deductions.
The IRS also has special rules for persons storing business inventory and for qualified daycare providers. If these deductions are of interest to you, be sure to investigate the special rules the IRS has for them.
Self-employed individuals should report these home office deductions on the Form 8829, Expenses for Business Use of Your Home. The summation should then be carried over to line 30 of Form 1040 Schedule C, Profit or Loss From Business.
Other rules apply to those who are not self-employed but who are allowed to work at home. The home office must be for the convenience of the employer. While it is convenient for the employee to walk from their bedroom and down the hall into their office, the IRS wants to know that the reason for the home office is for the employer’s benefit. The IRS will also want proof of this usually in the form of a letter from the employer that reads to the effect, “No home office, no job,” thus showing that employment is dependent on the ability to work from home.
This article is not to be considered tax advice and those wishing to claim home office deductions should consult the IRS Publication 587 and their tax advisor. The tax code is difficult to grasp with its vast amount of code in addition to its ever changing behavior, but knowing the basics should help to pinpoint the questions a person working from home should ask when considering home office tax deductions.