WFH Nation: Who Gets the Home Office Deduction?
Sorry, employees, it’s only the self-employed; how to avoid IRS unpleasantness
Millions of Americans who have been lucky enough to keep their jobs amid the COVID-19 pandemic are now working from home.
If you are self-employed as a small business owner, freelancer or contract worker, and you work primarily from a dedicated office in your house or apartment, you can probably claim the valuable home office deduction come tax time next year. But if you’re an employee who now dials into Zoom meetings while your toddler throws toys at you, you can’t, thanks to a change in the 2017 tax code overhaul.
Accountants and the IRS have long seen the home office deduction as ripe for abuse. So, knowing four key facts about how the deduction works could save you costly mistakes and stress down the road.
If you own or rent your dwelling and use part of your home for your business, you may be able to deduct business expenses tied to that use. Whether you are a freelance photographer or sell your hand-knit sweaters on Etsy, your home office has to be used “regularly and exclusively” as your “principal place of business.” So, no claiming the deduction while typing from your pillow-strewn bed or dining room table where you eat. If you work from multiple locations but claim your home office as your principal place of business, that probably won’t fly, either. The IRS’s rules on this are very prickly, and not following them can raise a red flag.
Ideally, your home office is a separate room. Obviously, that’s not always possible, particularly in small apartments in big cities like New York or Chicago. You need to have what the IRS calls a “separately identifiable space.” It doesn’t have to be sectioned off by a wall or Ikea-style cubicle structure. Many accountants say that installing a folding screen or curtain will do the trick. If you have a separate, free-standing structure, like a studio, garage, workshop or barn, and you use it exclusively and regularly for your business, that can also qualify for the deduction.
What can you deduct, and how do you calculate the amount? You can deduct from your taxable income certain expenses that are directly and proportionally related to the cost of your home office, like rent, mortgage interest, utilities, painting and repairs. You can also deduct the cost of supplies like computers and desks.
There are two ways to compute the deduction. The first is the regular method, and it’s a pain: You tally up your entire home’s total expenses and then compute a percentage of them for your home office, as measured in square feet. You also calculate depreciation of eligible property in your home office. In general, if your apartment is 1,600 square feet and your home office is 200 square feet, you would claim 12.5% of your total eligible expenses as your home office deduction.
The second, simpler, method lets you monthly deduct $5 per square foot of the portion of your home that is used for business, up to 300 square feet. For the example above, that would yield a deduction of $1,000.
It may seem obvious, but it’s important not to deduct expenses for any part of your home that is not regularly and exclusively used for business purposes.
What if you have more than one business, or share your home office with a partner who has a separate business? It gets complicated. No double-dipping: You can’t each claim a full deduction for one office. Consult your accountant, or this IRS advice.
Why does the IRS scrutinize the home office deduction? Deductions lower your taxable income and, thus, your final tax bill. The agency perennially worries that people will disguise living or personal expenses, like groceries and travel, as business expenses. For example, that you will improperly claim that a family vacation in Florida was really for the business you run out of your home office. The IRS is also on the lookout for taxpayers who try to take the deduction when their “business” is really a nonprofit hobby that’s done for sport or recreation, like raising thoroughbred horses.
Hopefully, the good news is that you’re working while self-isolating, you’re healthy and you still have a job. And if you’re among the 16 million Americans who are self-employed and still have a job and a dedicated home office, you just have to follow the IRS’s rules.
For those not self-employed, there may be a glimmer of hope: The IRS appears to be looking at whether employers can get a deduction for reimbursing employees for work at home costs. As for the mental cost of cranking out spreadsheets for your employer while your children smear peanut butter all over your desk, there’s no deduction for that.