Taxpayers sometimes prefer to avoid deductions that are “audit red flags.” While an audit is no fun, fear of an audit is no reason to avoid taking a home office deduction if you legitimately qualify for one.
In recent years, the IRS has made it easier to calculate a home office deduction, allowing you to choose to use the safe harbor method or the regular actual expenses method for any taxable year. But first, to take a home office deduction, specific rules must be met. It has to be your principal place of business. If you’re self-employed, it must be where you regularly perform your administrative or management activities, or meet with clients or patients. Next, you must be able to show you use your home office exclusively for business on a regular basis. This means the home office cannot also be your music room where you jam on your guitar on the weekends. The rules are very particular. For example, if you partition the room to include both a music room and a home office, only the home office portion of the room would be deductible. If your business involves selling a product, generally you can take a home office deduction for the area used to store your inventory.
If you are an employee who works from home or you are required to telecommute, you too may qualify for a home office deduction. The IRS requirements are the same; however, your home office must also be for the convenience of your employer, i.e., your employer must ask you to work out of your home.
Self-employed taxpayers claim the home office deduction on IRS form 8829, Expenses for Business Use of Your Home, when reporting income from their business on Schedule C, Profit or Loss from Business. If you are an employee, the home office deduction is taken as a miscellaneous itemized deduction on Schedule A of IRS Form 1040. Furthermore, this deduction is subject to the 2% limit for miscellaneous itemized deductions.
Depending on the method you use to calculate your deduction, you can deduct direct and indirect expenses including deductible mortgage interest, real estate taxes, rent if you do not own the home you live in, utilities including gas, electricity and trash removal, homeowners or renters insurance, any direct phone lines installed exclusively for the business, repairs to your home, casualty losses, security systems and depreciation.
Generally homeowners can exclude up to $250,000 in capital gains from the sale of their primary residence from federal income tax ($500,000 for married filing jointly). If you have taken depreciation on your home office, you may end up paying some taxes on the gain when you sell the home. The taxable amount will be considered unrecaptured Section 1250 gain, which is taxed at a rate of 25%.
Overall, deductions help taxpayers minimize their tax obligations. An accountant or tax adviser can help you determine the best method for documenting your expenses and stay within the rules to qualify for the deduction you are entitled to.
William G. Lako, CFP®
Shawna L. Theriault, CFP®, C.P.A.
William G. Lako, Jr., CFP®, serves as a principal at Henssler Financial. Shawna L. Theriault, CFP®, C.P.A. is a Managing Associate at Henssler Financial, specializing in assisting high net worth individuals, families and businesses in tax, financial and estate planning. Both Lako and Theriault are CERTIFIED FINANCIAL PLANNER™ professionals. Founded in 1987 by Gene W. Henssler, Ph.D., Henssler Financial provides solutions for individual, corporate and institutional clients that incorporate a range of services, including wealth management, financial planning, tax preparation and consulting, small-business retirement planning and estate planning. www.henssler.com