Advances in technology have made working from home increasingly common, with more Americans working from home. One important tax topic for telecommuters to know about is the home office deduction (expense deduction for telecommuters). This article explains the home office deduction under the US tax law.
Home office deduction conditions
Generally, you cannot deduct home-related items such as mortgage interest, property taxes, utilities, maintenance costs, rent, depreciation, and property insurance as business expenses. However, if you meet certain requirements, you may be able to deduct expenses related to some business expenses from your home.
To deduct your home business expenses, you must use a portion of your home as follows:
- You exclusively and regularly use your home as your principal place of business. (Exclusive use)
- If you store inventory or product samples related to your business.
(Exception 1 to the exclusive use) - If you are paying for day care. (Exception 2 to exclusive use)
- Exclusively and regularly used as a place where you meet or interact with patients, clients, or customers in the normal course of trade or business. (Trade or business use)
- If you use a separate structure that is not attached to your home in connection with your trade or business. (Use of a separate structure) or
- If you are renting.
Exclusive Use
To obtain the exclusive use requirement, certain areas of your home must be used solely for commercial or business purposes. A place used for business is a room or other separately identifiable place. There is no need to permanently separate locations. If the area is used for both business and personal purposes, the exclusive use requirement is not met.
Consider the following examples to see if the exclusive use requirement applies.
<Example 1>
Mike works in the law business and dedicates a room in his home to preparing legal documents and meeting with clients. The room is not used for any other purpose. The rooms in Mike’s house are individually identifiable spaces and are used only by his law practice. Meets exclusive use requirements and may qualify for home office deduction.
<Example 2>
Susan uses a room in her home to do translation work. When she’s not doing her translation work, her husband and her kids use that room to watch TV. The room that Susan is using is not only used for Susan’s business as it is used by her family for personal purposes, in this case as a TV room. Therefore, the room where Susan does her translation work is not eligible for the home office deduction. In other words, it does not meet the exclusive use requirement.
There are two exceptions to this exclusive use requirement:
Exception 1 to the Exclusive Use – Storage of Inventory and Product Samples
If you use a room in your home to store product samples or inventory at home, the space used for such storage need not meet exclusive use requirements and may be entitled to the home office deduction.
To qualify for the exception to the exclusive use requirement, all of the following tests must be met:
- Selling products wholesale or retail as a trade or business.
- Keeping inventory or product samples in your home for use in your trade or business.
- That your home is the only fixed location for your transactions.
- The storage space is used regularly. And,
- The space used must be a separately identifiable space suitable for storage.
<Example 3>
Kathy is a representative for a pharmaceutical company, and her only fixed place for work is her home. She keeps a large number of samples in a room in her home because her job requires her to see a doctor. She also occasionally uses one of her rooms as a yoga room. Kathy does not use her room solely to store product samples, but since she is an exception to the exclusive requirement if she is doing sample storage, the room is a home office. It is subject to deduction.
Exception 2 to the exclusive use – Use as a day care facility
The second exception to the exclusive use requirement is when you use space in your home for a day care facility.
To qualify for the exception to the exclusive use requirement, both of the following tests must be met:
1．Be engaged in a business that provides the following day care services:
a) The kids
b) People over 65 years old, or
c) A person who is physically or mentally unable to care for themselves. and,
2. Have applied for, been issued, or received an exemption for a license, qualification, registration, etc. or is approved as a day care center or family or group day care home under state law.
＜Example 4＞
Carol is licensed by the state to operate an adult day care. During her day, she provides care to people over the age of 65 in a large, airy room in her home. When this room is not being used for her adult day care business, she and the rest of her family use it as a TV and game room. The rooms that Carol uses for her adult day care business are not used exclusively for that business, but because they are day care facilities, they are an exception to the exclusive use requirement. Therefore, Carol can take the home office deduction.
Trade or business use
To qualify for the trade or business use requirement, part of your home must be used in connection with your trade or business. If you use your home for commercial activities that are not a trade or business, you cannot deduct that business use.
<Example 5>
Ken uses part of the house exclusively and regularly to read financial periodicals and reports, clip bond coupons, and perform activities related to his investments. Ken does not invest as a broker or dealer. Therefore, since Ken’s activities are not part of a trade or business, he is not eligible for the home office deduction.
Use of a Separate Structure
If you use a separate, detached structure, such as a studio, workshop, garage, or barn, exclusively and regularly for your business, you can deduct the cost of that building as a home office deduction. This building does not need to be your primary place of business or where you meet patients, customers, or customers.
<Example 6>
Amy runs a flower shop in town. Amy grows plants for her shop in a greenhouse that is a room in her home. Amy has exclusive and regular use of the greenhouse. Amy can get a home office deduction for her greenhouse. (There are certain restrictions.)
If you are renting
If you rent out a room in your home, you can deduct the expenses you incur from your rental activities, just like a landlord who rents out the entire property.
How to calculate home office deduction
If you are eligible for a home office deduction, you can calculate your deduction using the following method:
Actual Expense Method
The actual expense method of calculating home office deductions uses the actual expenses you pay as the basis for determining the allowable deduction for your business use. If you use the actual expense method to calculate your home office deduction, you cannot deduct business expenses for your home that are incurred during the year that you do not use the home for business purposes. Therefore, if you begin using part of your home for business purposes on July 1 of that year and qualify for the home office deduction, you cannot consider expenses for periods prior to July 1. Instead, you can only consider expenses for the period from July 1 to December 31 when calculating your allowable deduction.
The actual expense method requires you to determine:
・Nature of expenses. and,
・Percentage of home used for business purposes
Percentage of business
To find your business percentage, compare the size of the part of your home you use for business to the size of your home as a whole. Use the resulting percentage to calculate the business portion of the overall home operating costs.
Any reasonable method may be used to determine the percentage of business. Here are two commonly used methods to calculate percentages.
- Divide the area to be used (length x width).
For business, it is calculated according to the total area of the house. - If all the rooms in your home are approximately the same size, you can divide the number of rooms used for your business by the total number of rooms in your home.
<Example 7>
Donald’s home office is 240 square feet (12 feet x 20 feet). Donald’s entire home is 1,200 sqft. Donald’s office is 20% (240 ÷ 1,200) of the total area of his home.
<Example 8>
Diana uses a room in her home for work. Diana’s home has 10 rooms, all of approximately the same size. Diana’s office occupies 10% (1÷10) of the total area of her home.
Deduction Limit
If your gross income from the business use of your home is greater than or equal to your total business expenses (including depreciation), you can deduct all business expenses related to the use of your home.
If your gross income from the business use of your home is less than your total business expenses, the deduction of certain expenses for your home business use is limited.
Simplified Method
Instead of using the actual expense method when determining your home office deduction, you can use the simplified method available for years beginning January 1, 2013. For a home office deduction under the simplified method, the deduction amount is equal to the square footage of the taxpayer’s home (not to exceed 300 square feet) used for qualified business use multiplied by a prescribed rate. The current stated rate is $5, but the Internal Revenue Service and the Treasury Department may update the stated rate from time to time.
Selection of the simplified method cannot be canceled for that year. The choice whether to use the actual expense method or the simplified method is made annually.
Things to keep in mind when claiming the home office deduction
You should keep records of the information needed to calculate deductions for your home business.
You should keep any canceled checks, receipts, or other evidence of paid expenses.
The record must include the following information:
- A part of a home used for commerce or business.
- The exclusive and regular use of a portion of your home for business purposes, either as your principal place of business or as a place where you meet and deal with clients and customers in the normal course of business. However, see “Exceptions to Exclusive Use Requirement for Deductibility” above.
- Trade or business portion depreciation and expenses.
Please keep your records until the later of the following dates:
・3 years from the tax return filing deadline or tax return filing date.
・2 years after I paid your taxes.
Summary
Under the US tax law, there is a home office deduction for people who work from home. This deduction has exclusive use and business use requirements, and certain exceptions also exist. If you meet the requirements for a home office deduction, you’ll need to compare room sizes to calculate your business percentage and check your deduction limits. It is important to record and keep the necessary information when claiming deductions.
Comment