May 23, 2020

The Home Office Deduction: How to Write Off Expenses for Use of Your Home

Tax Deductions and Credits

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Do you use part of your home for running your business? If you’re like most business owners, the answer is yes.

The costs incurred to maintain a home office are deductible on your tax return.

We’ll walk you through the details of the home office deduction.  

Home Office Deduction Overview

What is the home office deduction?

If you use part of your home for business, you may be able to deduct some of your home expenses from your tax return.

Who can claim the home office deduction?

The home office deduction can be claimed by both renters and homeowners.

The home office deduction can only be claimed if you’re self-employed and own a business.

W-2 employees who work from home at the convenience of their employer can’t take the home office deduction. This changed in 2018 with the Tax Cuts and Jobs Act.

How do I claim the home office deduction?

You claim the home office deduction on Line 30 of Schedule C of your tax return.

Qualifying for the Home Office Deduction

There are two primary requirements to qualify for the home office deduction.

  1.     The home office must have exclusive and regular use, and
  2.     The home office must be the principal place of business.

There are exceptions for separate structures that aren’t attached to your home, storing inventory and product samples, meeting clients or patients at your home, and daycare facilities.

We’ll cover those exceptions a little later.

Home Office Must Have Exclusive and Regular Use

You must use your home office exclusively and regularly for your business.

Exclusive Use

The area doesn’t need to be a permanently defined space like a guest bedroom or a den. It could be half of your master bedroom or a corner in your dining room. As long as the space is exclusively used for business purposes, it qualifies.

For example, if you use your home’s den to do your scheduling but your family also uses the den as a kids’ playroom, then the den isn’t exclusively used for business purposes, and you can’t claim the home office deduction.

Regular Use

The space must also be regularly used for business.

For example, you’re an electrician and typically prepare client estimates at your client’s location. Occasionally you don’t have time to do the on-site estimate and instead create them at home on the computer in the spare bedroom. This occasional use of the spare bedroom doesn’t qualify as regular use.

Home Office Must Be Your Principal Place of Business

Your home office must be your principal place of business. What does that mean?

It means that your home office must be where you spend the most time and where you complete most of the important business tasks.

Multiple Locations and the Administrative Home Office

What if your business has more than one location?

For example, you operate an auto repair business and have a garage across town where you work on cars. You do all of your work, including administrative tasks, at the garage. The garage is your principal place of business and you can’t claim the home office deduction.

But if your business has multiple locations and you complete all of your administrative tasks at your home office, then your home office qualifies as the principal place of business. This means you can claim the home office deduction.

In the auto repair example above, if you complete all your administrative tasks at your home office and not at the garage, then the home office qualifies as the principal place of business and you can claim the home office deduction.

Exception #1: Separate Structures: A non-principal place of business exception

You can claim the home office deduction if you use a space that is detached from your home.

This separate structure must be exclusively and regularly used for business to qualify but need not be your principal place of business.

For example, you own a floral shop in town. You have a greenhouse behind your home where you regularly grow flowers that you sell exclusively in your shop. The greenhouse qualifies for the home office deduction even though the floral shop is your principal place of business.

Exception #2: Storing Inventory or Product Samples: A non-exclusive use exception

If you use part of your home to store inventory or product samples, you may claim the home office deduction, even if the use isn’t exclusive.

You’ll need to meet the following criteria to claim the deduction for inventory or product sample storage.

  1.     You sell products at wholesale or retail as your business.
  2.     You keep the inventory or samples in your home for use in your business.
  3.     Your home is your only fixed location for your business.
  4.     You use the storage space regularly.
  5.     The space used is separately identifiable and suitable for storage.

Exception #3: Meeting Clients or Patients at Your Home: A non-principal place of business exception

Providing services to clients or patients in your home while also providing services at another location, qualifies for a home office deduction if you meet two requirements.

  1.     You physically meet with clients or patients at your home and
  2.     Their use of your home is substantial and integral to your business.

Attorneys, accountants, or hair stylists are some professionals that will meet these requirements.

Exception #4: Daycare Facilities: A non-exclusive use exception

If you operate a daycare facility from your home, you may claim the home office deduction even if you don’t meet the exclusive use requirement.

For example, you use your kitchen for preparing meals for your clients and for your family. Even though your kitchen isn’t exclusively used for your daycare business, you might be able to claim the deduction if you meet two requirements.

You’ll need to:

  •       Be in the business of providing daycare for children, adults aged 65 or older, or people with physical or mental ailments and can’t care for themselves and
  •       Be licensed, or exempt from licensing, as a daycare center or group home in your state.

Calculating the Home Office Deduction

You have two options to calculate the home office deduction: actual expenses or the simplified method.

Actual Expenses Method

Use Form 8829 to calculate your home office deduction using actual expenses.

Start by calculating the percentage of your home used for business purposes.

For example, assume you use an extra bedroom as your home office. The bedroom is 200 square feet and your home is 2,000 square feet. You use 10% (200 / 2,000) for business use.

Next, gather all expenses for your home and group them by direct and indirect expenses.

Direct expenses benefit only the business use of your home. Perhaps you painted or installed new lighting in your home office. These would be direct expenses.

Indirect expenses are those for the general running of your entire house. These include utilities, insurance, or security service.

All direct expenses are 100% included in your deduction.

All indirect expenses are allocated between business and personal use. The percentage related to business use is included in your deduction.

Simplified Method

You can use the easier method of calculating your home office expenses by using the simplified method.

Multiply the area of your home used for business by $5. For example, if you use 200 square feet for business, you’ll deduct $1,000 ($5 x 200) for business expenses.

You don’t need to keep track of direct or indirect expenses using the simplified method.

Simplified Method is Limited

The maximum square footage you can use with the simplified method is 300 and therefore the maximum deduction you could take using the simplified method is $1,500.

Which Is Better, the Simplified Method or Actual Expenses Method?

Actual expenses are better if you use a large portion of your home for business.

Since the simplified method caps the business use of your home at 300 square feet, use actual expenses if you use more than that.

However, the simplified method is better for those who dread recordkeeping. You won’t have to keep receipts for all your utility bills or do the math to allocate those expenses to your home office.

Indirect Expenses: Depreciation

What is Depreciation?

Depreciation is an allowance for normal wear and tear. It’s a cool trick that allows you to deduct a portion of the cost of your property each year even though real estate usually increases in value.

Benefits of Claiming Depreciation Expense

Using your home for business allows you to claim depreciation expense. It can increase your home office deduction and decrease your taxable income.

Beware of depreciation recapture though. We’ll discuss that later.

How to Calculate Depreciation

To calculate depreciation, you’ll need to know four things:

  1.     The month and year you started using your home for business.
  2.     The adjusted basis and fair market value of your home (excluding the value of the land) when you began using it for business.
  3.     The cost of any improvements before and after you began using your home for business.
  4.     The percentage of your home used for business.

The adjusted basis of your home is its cost (including any capitalizable expenses from your closing statement) plus any permanent improvements you made to it. 

Keep in mind that you are allowed to depreciate the value of the home but not the land. Land is a non-depreciating asset.

So after you calculate your property’s basis, you will need to bifurcate it between land and building.  An easy way to do this is to look at the county assessor’s land/building split on your property tax bill and apply those percentages to your basis.

Let’s look at a comprehensive example:

  •       You purchased your home for $200,000 in July 2015. The value of the home is $150,000 and the value of the land is $50,000.
  •       You replaced the roof for $10,000 in July 2017
  •       You added a swimming pool for $20,000 in August 2015
  •       You repaved the driveway for $3,000 in December 2018
  •       You repaired the flooring in the laundry room after your dog ate part of it for $2,500 in December 2017
  •       You began using your home for business in February 2019
  •       For business, you use 100 square feet of your home’s 1,500 square feet
  •       The fair market value of your home in February 2019 is $275,000

The adjusted basis of your home in February 2019 is $183,000 ($150,000 + $10,000 + $20,000 + $3,000). The repaired flooring is a repair and not a permanent improvement.

Since the adjusted basis is less than the fair market value, you’ll use the adjusted basis to calculate depreciation. You will always use the lessor of your adjusted basis or the fair market value for depreciation calculations.

You’re using 6.66% (100 / 1,500) of your home for business.

The depreciable basis of your home for business is $12,198.78 (6.66% x $183,000).

You’ll use the IRS’s percentages to calculate how much depreciation expense you can include in your home office deduction for the first year.

Since you started using your home for business in February 2019, you’ll use 2.247% of the depreciable basis. This means you’ll have $274.11 (2.247% * $12,198.78) in depreciation expense to include in the 2019 home office deduction.

Is Depreciation Expense Limited?

Yes. If your business income is less than your business expenses, depreciation expense can be limited. But there is good news: any unallowed expenses can be carried over to the next year.

Selling Your Home, Gains, and Depreciation Recapture

Selling your home may allow you to exclude up to $250,000 of gain from taxes if you meet certain criteria for ownership and use.

But if you claimed a home office deduction for business use of your home, things are a little trickier.

Recognizing Gains and the Home Office Deduction

Whether you can exclude any gain related to the business use of your home will depend on if the business use is within the walls (e.g. bedroom in the house) or outside the walls (e.g. a greenhouse in the backyard).

In short, if the business use of your home is within the walls, you can exclude any gain. If it’s outside the walls, you can’t.

Depreciation Recapture: What’s that?

If you sell your home, you’ll need to recapture any depreciation you deducted or could have deducted from your tax return if you used the actual expense method.

This is important: Even if you didn’t include depreciation in your home office deduction, any amount of depreciation you could have deducted will decrease the basis of your home when you sell it.

This means that if you sell your home for a gain, your gain will be larger.

Conversely, if you sell your home for a loss, your loss will be smaller.

Continuing from our example above..

You sell your home for $300,000 on December 31, 2019. 

Your basis in the home is $183,000 and you could have taken $274.11 in depreciation for 2019. Your adjusted basis in the home is $182,725.89 ($ 183,000 – 274.11). The $274.11 reduction represents the depreciation recapture. You have a $117,274.11 ($300,000 – $182,725.89) gain.

How is Recaptured Depreciation Taxed?

Recaptured depreciation is taxed at the greater of your marginal tax rate or 25%.

So if you sell your home for a gain, and your marginal tax rate is at least 25%, the amount of depreciation you could have deducted for your home office is taxed at 25%, while the remaining gain is taxed at the normal capital gains tax rates.

In our example above, $274.11 would be taxed at 25% and $117,000 would be taxed at capital gains rates.  

Calculating the Recaptured Depreciation Amount

Nonresidential real estate is depreciated over a 39-year life.

Calculate the business basis of your home and divide that number by 39 to get your annual depreciation amount.

For example, your home was purchased for $200,000 and you’ve made no permanent improvements. You use 10% of the square footage for your home office. Your basis in the business portion of your home is $20,000 ($200,000 * 10%).

Your annual depreciation for the business portion of your home is $512.82 ($20,000 / 39). And if you used your home for business for only one year, then $512.82 of any gain will be subject to depreciation recapture taxation.

Recordkeeping: What to Keep and For How Long

What Should You Keep?

In addition to documents showing the original purchase price of your home, you’ll need to keep all receipts for permanent improvements. New roof, new windows, replaced HVAC, or upgraded water heater all qualify as permanent improvements.  

How Long Should You Keep Records?

Keep your records for at least three years after you filed your return or two years after the tax was paid, whichever is later.

For example, if you claimed a home office deduction on your 2017 tax return and you filed your return on April 15, 2018 and paid your tax due on the same date, you’ll need to keep your records until at least April 15, 2021.

Home Office Deduction Frequently Asked Questions

  • I own two rental properties. Can I take a home office deduction?

    It depends. Whether you can take the home office deduction will hinge on whether your rental properties qualify as a trade or business (i.e. you materially participate on a continuous basis by doing things like advertise the property, resolve tenant issues, or complete repairs). If it qualifies as a trade or business, then you can claim the home office deduction.

    If you have them strictly for investment purposes (i.e. you sit back and collect rent), you won’t be able to claim a home office deduction.

  • My outside accountant does all my billing and bookkeeping. Does this mean I don’t qualify for the administrative home office classification?

    No. You can still claim your home office deduction even if your outside accountant completes your bookkeeping at their location.

  • I began using my home office in the middle of 2019. How much can I claim for the home office deduction on my 2019 tax return?

    You can claim the months your home was used for business.

    For example, if you started using your home in July 2019, you can take six months of indirect expenses and all direct expenses incurred from July – Dec 2019.

  • Do I need to calculate depreciation to claim the home office deduction?

    No. You don’t have to calculate depreciation to claim the home office deduction if you use the simplified method.

  • My home office is my principal place of business and I regularly have to travel to client offices. Can I deduct mileage as part of my home office deduction for traveling to my clients?

    No. You’ll deduct this on line 9 of Schedule C. It’s not part of the home office deduction.

  • Can I include my real estate taxes and mortgage interest in my home office deduction?

    Yes but if you claim the standard deduction, you can only claim them to the extent they reduce your taxable income. You can’t claim these deductions if they will cause a loss or increase a loss. If you aren’t able to take these deductions in the current year, you can carry them forward and claim them in the future.

    home office deductions

Melissa Carraro, CPA

Melissa has nearly 20 years of experience as a CPA, having worked for both "Big 4" and smaller accounting firms.

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