Have you ever dreamed of working from home full time? It would mean no more commuting, no more office politics, and no more take-out dinners when you’re stuck at the office. Plus, there’s the added bonus of a potential tax deduction when you move your office into your home.
With all the perks, it’s no wonder that one in four American households—about 26 million—have home offices. According to a recent survey by CDB Research & Consulting Inc., seven out of ten home offices are used to operate small businesses.
However, according to the IRS, just 3.4 million taxpayers claim home office deductions, which averaged about $2,600 in 2010. Many avoid claiming the tax deduction because they fear triggering an audit, while others may not be sure their offices qualify for the deduction.
There are strict rules governing home offices. To see if your home office qualifies, consider the following.
1. Your home office must be a clearly designated space. Ideally, this space is a room that you use exclusively, and on a regular basis, for your business. If you work at a table in your living room, it probably doesn’t qualify. You cannot use your home office for other purposes, such as volunteer work or personal activities.
If your employer reimburses you for all or part of your home office, the reimbursements must be included in your income in order for you to deduct your home office expenses.
2. Your home office must be the primary place in which you conduct your trade or business or a setting to meet or deal with patients, clients, or customers. However, you do not need to do a majority of your work from your home office if your work requires you to be outside of that office such as, for example, if your business is sales, servicing, or repair.
3. Working from home one or more days a week when you have another office or workspace available to you doesn’t qualify unless you are an employee and your employer does not provide office space for you. You also don’t qualify if your employer reimburses you for your home office space.
4. Taxpayers who share a home, regardless of filing status, may each claim the deduction—provided they have separate and distinct home office areas.
Direct and indirect expenses
You can write off two kinds of expenses: direct and indirect. You can deduct 100 percent of direct expenses—those that are required for your business—including extra phone lines, Internet service, furniture, a computer and printer, and furnishings for the space you designated as your home office.
Indirect expenses are calculated based on the percentage of your home’s square footage represented by your home office. Multiply your home office percentage by the annual amount you spend on indirect expenses such as mortgage or rent, utilities, repairs and maintenance, HOA dues, property insurance, property taxes, and other expenses you pay to maintain the property. Landscaping can even be included if you use your office to meet with clients. Finally, you can deduct the value of depreciation to the home office portion of your home.
The new “safe harbor” option from the IRS
The IRS just announced a new “safe harbor” option to simplify home office deductions for the current tax year, 2013, but this may cost you some deductions. Instead of going through all the home office calculations and keeping receipts, the new home office rules will let you simply claim $5 per square foot of your home office, with a maximum write-off of $1,500 (based on a maximum of 300 square feet). You won’t be able to depreciate the part of your home used for business, though, if you go this route.
Taxpayers who have more than one qualified home office, i.e., in more than one home, may use the safe harbor method for only one home office space. A taxpayer cannot opt for the safe harbor method if he or she derives rental income from the same home as the qualified business use. If your employer reimburses you for your home office, you also cannot use the safe harbor option.
Because only about 3 percent of taxpayers are claiming the home office deduction, there’s no doubt that millions of people who work from home are missing out on an important deduction and overpaying their taxes. The new safe harbor rules may make it easier for those taxpayers to lower their tax liability by claiming the expenses they are spending on making a living from home.
Steve Cook is executive vice president of Reecon Advisors and covers government and industry news for the Reecon Advisory Report. He is a member of the National Press Club, the Public Relations Society of America, and the National Association of Real Estate Editors, where he served as second vice president. Twice he has been named one of the 100 most influential people in real estate. In addition to serving as managing editor of the Report, Cook provides public relations consulting services to real estate companies, financial services companies, and trade associations, including some of the leading companies in online residential real estate.