Laura reviews who qualifies for the home office tax deduction and five rules for claiming it when you work from home.
Laura reviews who qualifies for the home office tax deduction and five rules for claiming it when you work from home.
Money Girl is hosted by Laura Adams. A transcript is available at Simplecast.
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If you work from home, you may be eligible to claim the home office deduction, which can significantly reduce your taxes. It's available if you have part- or full-time self-employment income and whether you rent or own your home.
This post will explain how the home office deduction works, who qualifies, and five rules for claiming it, no matter what type of venture you run from home.
If you want to learn more about this topic, check out chapter 14 of my book, Money-Smart Solopreneur: A Personal Finance System for Freelancers, Entrepreneurs, and Side-Hustlers, which covers loads of tips for saving money when you have a home office.
Welcome back! I appreciate you joining me for Money Girl episode 900! I'm Laura Adams, an award-winning author, on-camera spokesperson, female money speaker, founder of The Money Stack, a Substack newsletter, and host of Money Girl with over 43 million downloads.
If you enjoy the free content we love creating for you, please take a moment to rate and review the show in your podcast app! If you have a question about money, leave it on our voicemail at 302-364-0308. You can also visit LauraDAdams.com to email me and learn more about my books, courses, and the free Money Stack newsletter.
5 rules for claiming the home office tax deduction
Here are five rules you should know about claiming a home office tax deduction in any given year.
1. You must have business income.
If you work for yourself in any trade or business, either part- or full-time, and your primary office is in your home, you likely have a home business for tax purposes. It doesn't matter if you're an online retailer, a freelance writer, a consultant, an Uber driver, or a dog walker.
You can have a home-based business even if you mostly earn income outside the home. That's common for many tradespeople and solopreneurs, such as musicians, sales reps, and gig workers.
If you're self-employed and do administrative work–such as scheduling, invoicing, communication, and record-keeping–at a home you rent or own, you can claim the home office tax deduction.
However, if your only source of income is working from home as a W-2 employee, you can't claim a home office deduction. Before 2018, employees used to be allowed to claim it, but that tax perk is no longer available. Now, you must have self-employment income to qualify for the home office deduction.
If you're a work-from-home employee, you might request expense reimbursement for your office setup costs from your employer; however, they're not obligated to pay you for it.
RELATED: Sole proprietorship vs LLC–pros and cons for your small business
2. You must have a dedicated office space.
The second home office deduction rule is that you must have a space used regularly and exclusively for conducting business. For example, if you use an extra bedroom, a detached garage, or a nook in your studio apartment to run your business, you can claim a deduction based on the space size relative to your entire home. I'll explain more about calculating the home office deduction in a moment.
While you don't need walls to separate your office, it should be a distinct area in your home so you can determine its size. The only exception is when you use part of your home for business storage or as a childcare business. In those situations, you can consider the entire space an office for tax purposes.
A tax-deductible home office must also be the primary place where you run your business, but it doesn't have to be your only workplace. For example, if you do administrative work at home and meet clients in other places, you can still consider the area of your home used exclusively for business as your home office.
Plus, you might do work at a co-working space or coffee shop from time to time and still have a legitimate home office. Again, you don’t have to meet customers at home or have any special equipment there to qualify for the home office deduction.
3. You can deduct direct office expenses.
When you have a home office, one type of deduction you can claim is for your direct expenses. Those are costs you incur to set up and maintain your office space.
For instance, if you work in a spare bedroom, you might install new carpet, paint the walls, and purchase a desk. You could have necessary repairs or maintenance, like replacing a broken window or door lock for your office.
Your direct office expenses are 100% deductible, no matter the size of the space. So be sure you keep track of any upgrades or furnishings for your home office so you can use them to help reduce your taxes.
4. You can deduct indirect office expenses.
In addition to direct expenses, one of the best aspects of having a home office is deducting all your office’s indirect expenses. These costs are related to your office but affect your entire home or apartment.
For instance, if you're a renter, the cost of rent, renters insurance, and utilities are examples of indirect expenses. You'd have to pay them even if you didn't have a home office.
For homeowners, potential indirect expenses typically include your mortgage interest, property taxes, homeowners insurance, utilities, and maintenance. While you can't deduct the principal portion of your mortgage payment, which is the amount you borrowed, you can recover a part of your home’s cost annually through depreciation deductions using an IRS formula.
In other words, allowable indirect expenses turn some of your household costs into home office deductions, which is terrific! However, they're deductible based on the size of your office as a percentage of your home–unless you use a simplified calculation, which I'll cover next.
However, expenses unrelated to your home office, like adding a pool or remodeling a kitchen are never tax-deductible. So, your ability to deduct costs when you run a business from home depends on whether it benefits your office directly (such as furnishing it) or your entire home (such as power, water, and insurance) as an indirect expense.
In addition, you’ll likely have many business expenses unrelated to your home office or home, such as marketing, office supplies, equipment, and professional services. Expenses you incur to run and grow your business are fully deductible no matter where you work.
LISTEN ALSO: Will renting or owning a home make you wealthier?
5. You must choose a calculation method.
If you qualify for a home office deduction, you can calculate it in two ways: the standard method or the simplified method.
The standard method requires you to keep good records and determine the percentage of your home used for business. You calculate and divide the square footage of your office by the square footage of your entire home.
For example, if your home office is 12 feet by 10 feet, that's 120 square feet. If your entire home is 1,200 square feet, dividing 120 by 1,200 gives you a home office space that's 10% of your home.
That means 10% of the qualifying indirect expenses of your home can be attributed to your business, and the remaining 90% would be for personal use. If your monthly power bill is $100 and 10% of your home qualifies for business use, you can consider $10 of the bill a tax-deductible home office expense.
To claim the standard method deduction, use Form 8829, Expenses for Business Use of Your Home, to calculate your deductible expenses and file it with Schedule C, Profit or Loss From Business.
The simplified method allows you to claim $5 per square foot of your office area, up to a maximum of 300 square feet. So, that caps your deduction at $1,500 (300 square feet x $5) per year.
The simplified method is straightforward because you don't have to do any record-keeping; you measure the space and include it in Schedule C. It works best for small home offices, while the standard method is better when your office is larger than 300 square feet. You can choose the method that gives you the biggest annual tax break.
But no matter which method you choose to calculate a home office tax deduction, you can't deduct more than your business' net profit. However, you can carry deductions forward into future tax years.
As you can see, claiming tax deductions for your home office can get complicated. If you have questions about qualifying business and home office expenses, consult a qualified tax accountant to maximize every possible deduction and save money. The cost of working with a trusted tax pro is worth every penny because they will probably save you more than their fee.
That's all for now. I'll talk to you soon. Until then, here's to living a richer life!
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