A taxpayer may deduct a portion of their home for business use expense if it is used exclusively and regularly as a place of business. This deduction is available to both employees and the self employed. Employees must meet the additional test of for the convenience of the employer. The “regularly” and “exclusively” rules are strictly construed.
The exclusive use test means a “portion of the dwelling unit” must be used only for carrying on a trade or business. A part of a room will qualify so will a walk in closet. The office space need not be physically separated with a wall or other partition. The “office” cannot be used for even occasional personal use, such as watching television or as a spare bedroom when the mother-in-law visits.
If the home is the principle place of business and is used to store inventory, the requirement for storage areas is lower and does not have to meet the exclusive use test. Using a percentage of the garage for storage, even though it is not exclusive space yields a deduction.
The regular use test is normally met if it is the principle place of business. Keeping a calendar of client visits is a good practice if there is a question about regular use.
An employee must meet the ‘convenience of the employer’ requirement that is interpreted to mean the employer provides either no office or inadequate office space for the employee. This is a litigated area. Even if the office the employer provides is 30 miles away it still would most likely make the employee ineligible for the business use of home deduction because the employer did provide an office, the inconvenience of the employer provided office does not matter.
The IRS is very tough on the employee home office issue. Even if the employer wants you to have a home office and gives or lends you office equipment to set up shop at home the expense for home office may not be allowed. The interpretation is normally that unless you would not have a job but for having a home office, you are not entitled to the deduction. If you are in this situation consider getting the employer to write into the employment agreement you are required to maintain a home office.
The normal method of determining the percentage of business use is to measure the square footage of the home work space and divide by total square footage of the residence including the basement. You are not limited by this method. Any appropriate method is acceptable, for instance if all rooms are roughly the same size and one room in a five room home is used as an office you could allocate one fifth of the dwelling to office use and hence deduct one fifth of the expenses of the residence.
Based on percentage of use, real estate taxes, interest, insurance, repairs, utilities, grass cutting, rubbish and everything associated with maintaining the house can be deducted. This may be beneficial to a taxpayer who does not itemize. A portion of real estate taxes and interest can still be deducted as home office expense. See IRS form 8829.
Depreciation is calculated as though the office percentage of the home was a commercial building and generally taken over 39 years. At a future date when the residence is sold that depreciation must be recaptured, and is not subject to exclusion from income under sale of residence rules.
If it is possible to determine electricity or utility use of the office, a different percentage of use of utilities of other expenses can be taken as a tax deduction. Heavy use of office or other equipment should be taken into account.
If you paint the home office or have other expenses exclusively concerned with the home office they do not need to be allocated they are totally deductible.
It should be noted a home office used strictly for investment purposes does not qualify for home office deduction, even if the office is used full time, 40 hours per week. If the investor is considered a “trader” he is then in business and would make the home office expense deductible.
The home office deduction is also limited by the income of the business. Home office expense cannot be deducted in excess of income.
Home office, like most tax deductions depends on the ability to document the expense. The standard caution here is to keep good records.