The federal tax law signed by President Donald Trump Dec. 22, 2017, may affect home ownership tax benefits described in this article. The new law goes into effect for the 2018 tax year and generally doesn’t affect tax filings for the 2017 tax year. Here’s a detailed summary of the changes.
If you work from home, even on a part-time basis, you can probably save some dough come tax time by deducting your home office costs.
The challenge has always been the 43-line, MENSA-like IRS form home office workers had to complete, which may have kept some from even taking advantage of this home tax benefit.
There’s an optional, simplified home office deduction: Take $5/sq. ft. up to 300 feet or $1,500 and, boom, you’re done.
What’s the catch? Trade-off is a better word: You may not be able to deduct as much compared with the regular method. The IRS says the average home office deduction has been around $3,000. So consider the value of your time against potential tax savings if you believe you’re eligible for more than the $1,500 cap.
Before you start spending your refund, however, there are a few rules you need to heed.
What Counts as a Home Office?
A room or defined area of your home that you use exclusively and on a regular basis for business and that meets either of these uses:
- It’s your principal place of business, or
- You see clients, customers, or patients there.
Exception to the “exclusive” rule: If you use your home as the sole location of your business and store products there, the room or area where you store products can be used for other things. Say you use a room in your basement to make and store jewelry that’s also a TV room. If it’s the only fixed location of your business, you can use it to also watch TV.
What If You’re on the Road a Lot?
You don’t have to do all your work from home to take the home office deduction. If you’re an outside salesperson, you probably spend most of your work time elsewhere. But the home office has to be essential to your business, and you must spend substantial time there. If you do your billing and other office work from your home office, and there’s no other location available to perform these functions, your home office should qualify for the deduction.
You can also qualify for the deduction if your employer requires you to work from home, as long as you don’t charge your employer rent.
A big catch: You must maintain the at-home office for your employer’s convenience, not your own. If you use your home office to finish reports at night or on weekends because you don’t want to work at your desk in your office downtown, you can’t claim the home office deduction.
But if your employer doesn’t have a headquarters and everyone works remotely, you’re good to go.
Also Covered Under the Tax Break
Separate structures on your property, like a detached garage you’ve converted to an office or studio.
Unlike an office inside your home, a separate structure doesn’t have to be your main place of business to qualify for a deduction. That’s because the IRS believes your family is less likely to use a separate structure as a part-time play area or den, says Mark Luscombe, principal analyst for tax and consulting at CCH.
Two Ways to Deduct Home Office Expenses
1. Simplified home office deduction. We talked about this one above, but there are a few other particulars to note:
- You can’t depreciate your home office, and your deduction is limited to your gross business income less business expenses.
- If you use this deduction, you can still claim the deductions every homeowner gets, like mortgage interest, real estate taxes, and casualty losses. Put those on Schedule A.
- Using the standard home office deduction won’t stop you from taking the deductions for other business expenses unrelated to your home, such as advertising, supplies, and employee wages.
- You don’t need to keep track of individual expenses with this option. You do with the actual cost method.
2. Actual costs, which you list on Form 8829. To use this method, you figure the proportion of your home’s overall space devoted to your office and use that to calculate how much of your overall home expenses went toward your home office.
Example: If your office is 300 sq. ft. and your home is 3,000 sq. ft., your office takes up 10% of your home. So you can deduct 10% of your utility, mortgage interest, property taxes, and other home expenses. However, certain expenses that aren’t related directly to the home office, such as lawn care, aren’t included in the calculation.
Not sure how big your house is? Check the documents you received when you bought your home — there’s probably a detailed rendering — or measure the outside of your home and multiply length times width.
Do You Have to Stick with the Same Deduction Method Each Year?
Nope. Each year, you get to decide whether to use the standard or the actual-expense deduction.
What Can You Deduct When You Use the Long Form?
If you’re using Form 8829 to report your actual expenses and you’ve figured out what percentage of your home you use for business, you can apply that percentage to different home expenses. These include:
- Mortgage interest
- Real estate taxes
- Utilities (heating, cooling, lights)
- Home repairs and maintenance (so long as they benefit both the business and personal parts of the home)
- Homeowners insurance premiums
Just take each expense and multiply it by your home office percentage to get the amount you can deduct as a business expense. So if you spend $150 a month on electricity, and your home office takes up 10% of your home, you can deduct $15 a month as a home office expense. That adds up to a $180 deduction per tax year.
Important limitation: Your home office deduction can’t exceed the amount of income you generate from the home office. So if you spend some of your work time on-site with a client and earn $1,500 there, you can’t claim more than $1,500 because it exceeds what you made at home.
Save bills or cancelled checks to prove what you spent in case of an IRS audit. Also, only repairs, like to the furnace, can be expensed; improvements must be depreciated.
Don’t Forget Depreciation
Depreciation is based on the idea that everything — even something like a home — wears out eventually. If you’re using the long form, figure home office depreciation by calculating the tax basis of your home:
- Add the purchase price to the cost of improvements.
- Subtract the value of the land it sits on.
- Multiply that cost basis by the percentage of your home used for work. This gives you the tax basis for your home office.
- Divide by 39 years.
- Purchase price: $100,000
- Value of land: $25,000
- Cost basis: $75,000, plus cost of improvements you’ve made
- Tax basis: $75,000 x 10% = $7,500
- Depreciation deduction: $7,500/39 years*
*Usually, depreciation deductions for a home office are figured over a 39-year period. There are caveats. For instance, if your business opened after Jan. 1 in its first year, you need to calculate a factor of 39. For a crash course, read IRS Publication 946 or talk to a tax pro.
Keep in mind that depreciation deductions on your home office may increase the amount of profit on a home sale that’s subject to taxes. Most taxpayers don’t owe income tax on up to $250,000 of profit if you’re a single filer, $500,000 for joint filers. Consult with a qualified tax professional on how depreciation deductions affect your tax liability when you sell.
Special Rules for In-Home Care Providers
If you provide in-home daycare services for children, the elderly, or disabled persons as a licensed or authorized business, you don’t have to use the home work space exclusively to take the home office deduction.
You calculate your deduction by dividing the number of hours you used your home workspace to provide daycare services during the year by the total number of hours during the year.
For example, if you do daycare 40 hours a week for 50 weeks a year, that’s 2,000 hours a year, divided by the 8,760 hours in a regular year equals 22.8%. So you could take 22.8% of the $5 per sq. ft. simplified deduction for your daycare workspace.
This article provides general information about tax laws and consequences, but shouldn’t be relied upon as tax or legal advice applicable to particular transactions or circumstances. Consult a tax professional for such advice.