According to the IRS, the majority of American taxpayers working from home do not claim a home office deduction even though they’re entitled to it. This is because they are unfamiliar with the rules governing the deduction and they are wary of its record-keeping requirements. They are also afraid of being audited by the IRS, which commonly scrutinizes taxpayers claiming the deduction in order to deter underreporting of income by small businesses. However, as long as you are following the rules, your home office deduction should not give you any reason for concern of an IRS audit.
Determine your home office space
The part of your home you designate as your office must be used “exclusively” and “regularly” as your principal place of business, or as a place to meet with patients, clients or customers. However, there are 2 exceptions to the “exclusively” rule: (1) you are a qualified daycare provider using part of your home as a day-care facility, or (2) you use a portion of your home for inventory storage or product samples.
“Usually” is not the same as “exclusively”
“Exclusively” for business means you must use your home office space only for business all the time. You or your family cannot use the designated area for recreation purposes whatsoever; otherwise you are not qualified to take the deduction.
Principal place of business
Principal place of business means using your home office exclusively and regularly for administering or managing your business, such as dealing with and billing customers, clients or patients, as well as bookkeeping and writing reports.
Calculate the business percentage
There are two ways you can calculate the business-use percentage of your home. The first method is to divide the square footage (length x width) of your home office by the total area of your home. The second method divides the number of rooms used for business by the total number of rooms in your home. In order to use the second method, the rooms in your home must be approximately the same size.
Expenses you can deduct
You can fully deduct the cost of painting or repairs that pertain only to the business part of your home. You can deduct utilities, insurance, depreciation (if you own your home), rent (if you are paying rent), general repairs, and your security system based on the business percentage you calculated. You can also deduct real estate taxes, mortgage interest, qualified mortgage insurance premiums, and theft and casualty losses based on your business percentage, but these deductions are available to you even if you do not claim a home office deduction.
Home office in a structure not attached to your home
If your home office is in a separate structure not attached to your home, it does not have to be your principal place of business. However, it still must be used exclusively for business.
Home office deduction for employees
If you’re an employee working from home, you can claim the deduction if the exclusive and regular use of your home office is for the convenience of your employer. If you are renting part of your home used for business to your employer, then you are not allowed to take the deduction.
Report your deduction correctly on Form 1040
Self-employed taxpayers can use Form 8829 to determine their home office deduction and then report it on Schedule C, line 30. On the other hand, employees must itemize their deductions on Schedule A in order to claim the home office deduction and all other employee business expenses.
Maintain good records
Keep receipts and all other supporting documents of expenses relating to your home office. This includes documents to substantiate your home’s depreciable basis, such as purchase price, date acquired, and any improvements you made. You should keep your records for at least 3 years from the date you filed your tax return.
Take date-stamped photographs of your home office each year just in case you are audited. This is because you may claim the deduction on this year’s tax return but five years from now you might not even live in the same home. Date-stamped photographs will help you demonstrate to the IRS that you qualified for the deduction in the year it was taken.