Also, the home office deduction can be complex. You need to keep good records of your home expenses, allocate the expenses of operating your home between business and personal uses, and complete a special IRS form, Form 8829. Lots of people who qualify for the deduction don't take it because they don't think it's worth the trouble.
But in a rare move to simplify life for taxpayers, the IRS created a simplified optional home office deduction back in 2013.
Using this optional method, you simply deduct $5 for every square foot of your home office. But the deduction is capped at $1,500 per year. So, it can only be used for offices up to 300 square feet.
Using the optional method relieves you from having to keep records of your home office expenses such as utilities, rent, mortgage payments, real estate taxes, or casualty losses. And you don't have to complete Form 8829.
Homeowners using the square footage method can't claim a depreciation deduction for their home office. But they can claim allowable mortgage interest, real estate taxes, and casualty losses on the home as itemized deductions on Schedule A. These deductions don't have to be allocated between personal and business use, as is required under the regular method.
Business expenses unrelated to the home, such as advertising, supplies, and wages paid to employees are still fully deductible.
It's important to understand that all the regular rules for qualifying for the home office deduction still apply even if you use the optional method. To qualify, you must meet any one of the following requirements:
Is it a good idea to use the simplified home office deduction? Only if the deduction you could obtain using the regular method isn't much more than $1,500.
Most people with home offices, particularly those who rent their homes, can qualify for a home office deduction much larger than $1,500. For example, a person with a 100-square-foot home office who pays $2,000 per month in rent and utilities would qualify for a $500 deduction using the optional method (100 sq. ft. x $5 = $500). If the home office took up 10% of the home, the renter would get a $2,400 deduction using the regular method (10% x $24,000 = $2,400). The inability to deduct depreciation doesn't make the optional method so great for homeowners either.
If you're thinking about using the optional method, you should figure out your deduction using both methods and use the method that gives you the largest deduction. Doing the required calculations and filling out the form can be challenging, but will be much easier if you use tax preparation software.
Also, the regular method requires more recordkeeping than the optional method, but you probably keep these types of records anyway.
If you have questions about the simplified home office deduction or any other deductions, contact a tax lawyer.
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The bad news is that the rent you receive is taxable income that you must report to the IRS.
The good news is that your taxable rental income can be wholly or partly offset by the tax deductions you'll be entitled to.
If you rent out a room in your home, the tax rules apply to you in the same way as they do for landlords who rent out entire properties. This means you get to deduct the expenses arising from your rental activity. There is one big difference however: You must divide certain expenses between the part of the property you rent out and the part you live in, just as though you actually had two separate pieces of property.
You can fully deduct (or, where applicable, depreciate) any expenses just for the room you rent—for example, repairing a window in the room, installing carpet or drapes, painting the room, or providing your tenant with furniture (such as a bed). In addition, if you pay extra homeowners’ insurance premiums because you’re renting out a room, the full cost is a deductible operating expense. If you install a second phone line just for your tenant’s use, the full cost is deductible as a rental expense. However, you cannot deduct any part of the cost of the first phone line even if your tenant has unlimited use of it.
Expenses for your entire home must be divided between the part you rent and the part you live in. This includes your payments for:
You can also deduct depreciation on the part of your home you rent.
You can use any reasonable method for dividing these expenses. It may be reasonable to divide the cost of some items (for example, water) based on the number of people using them. However, the two most common methods for dividing an expense are either based on the number of rooms in your home or based on the square footage of your home.
Example 1: Jane rents a room in her house to a college student. The room is 10 × 20 feet, or 200 square feet. Her entire house has 1,200 square feet of floor space. Thus, one-sixth, or 16.67% of her home is rented out. She can deduct as a rental expense one-sixth of any expense that must be divided between rental use and personal use.
Example 2: Instead of using the square footage of her house, Jane figures that her home has five rooms of about equal size, and she is renting out one of them. She determines that one-fifth, or 20%, of her home is being rented. She deducts 20% of her expenses that must be divided between rental and personal use.
As the examples show, you can often get a larger deduction by using the room method instead of the square footage of your home.
Be sure to keep good records of your deductible expenses when you rent out a room.
You may also qualify for the new pass-through tax deduction established by the Tax Cuts and Jobs Act. Starting in 2018 (and scheduled to last through 2025) pass-through business owners—that is, owners of any business other than a regular C corporation—may deduct up to 20% of their net business income from their income taxes (less if taxable income exceeds certain levels). Renting a room to short-term guests can qualify as a business, especially if you earn a profit each year. Thus, if you own and operate your room rental activity as an individual (or tenant in common) or through an LLC or partnership, you may qualify for this valuable deduction.
For more on this topic, see Tax Guide for Short-Term Rentals: Airbnb, HomeAway, VRBO and More, by Stephen Fishman.
]]>The cost of repairs to business property is a currently deductible business expense—that is, you can deduct the entire amount in a single year. On the other hand, if an expense constitutes an improvement to your home instead of a repair, the cost will have to be depreciated over many years. Determining whether an expense is a repair or an improvement can be difficult. However, the basic rule is that you must depreciate an expense you incur to:
Expenses you incur that don’t result in a betterment, restoration, or adaptation are currently deductible repairs. For example, replacing the entire roof of your home is an improvement. Replacing a few roof shingles with new shingles of equal quality is a repair. Similarly, replacing the wall-to-wall carpet in your office is an improvement. Fixing a hole in your existing carpet is a repair.
The IRS divides home office expenses into two categories: direct expenses, which benefit only your home office, and indirect expenses, which benefit both your office and your home.
You have a direct home office expense when you pay for something just for the home office portion of your home. The entire amount of a direct home office expense is deductible.
Example: Jean pays a handyman $100 to fix the window in her home office that won't close properly. She may deduct this entire amount as part of her home office deduction.
An indirect expense is a payment for something that benefits your entire home, including both the home office portion and your personal space. You may deduct only a portion of this expense—the home office percentage of the total.
Example: Jean pays $1,000 to repair the roof on her home. This is an indirect expense because it benefits her entire home. She may deduct her home office percentage of the expense. She uses 15% of her home as an office so she may deduct 15% of the cost, or $150.
You can deduct the home office percentage of home maintenance expenses that benefit your entire home, such as housecleaning of your entire house, roof and furnace repairs, and exterior painting. These costs are deductible whether you hire someone or do them yourself. If you do the work yourself, however, you can only deduct the cost of materials, not the cost of your own labor. Termite inspection, pest extermination fees, and snow removal costs are also deductible. Home maintenance costs that don’t benefit your home office—for example, painting your kitchen—are not deductible at all.
]]>For renters who live in high-cost areas like New York City or San Francisco, the home office deduction can be substantial. In one case, a public relations professional who worked out of a home office in her Manhattan studio apartment was entitled to an annual home office deduction of $9,293.
Some restrictions on taking the home office deductions can make it difficult for people who live and work in small apartments to qualify for it, particularly the exclusive use test.
You can’t take the home office deduction unless you use part of your apartment or home exclusively for your business. In other words, you must use your home office only for your business. However, this requirement doesn’t apply if you store inventory at home or run a home daycare center.
If you use part of your home, such as a room or studio, as your business office, but you also regularly use that same space for personal purposes, you won’t qualify for the home office deduction.
The easiest way to meet the exclusive use test is to devote an entire room in your home to your business. For example, you could use a spare bedroom as your office.
Not everybody has an extra room to spare, and the IRS recognizes this fact. You can still claim the deduction even if you use just part of a room as your office, as long as you use that part exclusively for business.
However, as a practical matter, people who live in very small apartments can have a hard time convincing the IRS or tax court that they use part of their space only for business.
One taxpayer, a psychologist who lived in San Francisco, claimed a home office deduction for one-quarter of her apartment. The entire apartment was a 400-square-foot studio consisting of an open area (approximately 13 feet by 15 feet) furnished with a desk and a couch and a small dining area and kitchen (each approximately 7 feet by 8 feet). The area of the apartment this taxpayer said she used exclusively for business purposes was also the main passageway through the apartment.
Given the layout of this tiny apartment, neither the IRS nor the tax court believed her claim that she used 100 square feet exclusively for her psychology business and she wasn't allowed to take the deduction. (Mullin v. Comm’r, TC Memo 2001-121).
On the other hand, another taxpayer, with a 700-square-foot studio apartment in Manhattan, did qualify for the home office deduction. She was a public relations professional and divided her apartment into three equal sections: (1) an entryway, a bathroom, and a kitchen area; (2) an office space, including a desk, two shelving units, a bookcase, and a sofa; and (3) a bedroom area including a platform bed and dressers.
She admitted that she had to pass through the office space to get to the bedroom area. Nevertheless, the tax court found that the office area of her apartment satisfied the exclusivity requirement for the home office deduction. It held that “her personal use of the space was de minimis and wholly attributable to the practicalities of living in a studio apartment of such modest dimensions.” (Miller v. Comm’r, T.C. Summary Opinion 2014-74).
If you use the same room (or rooms) for your office and for other purposes, you should arrange your furniture and belongings so that a portion of the room is devoted exclusively to your business. Place only your business furniture and other business items in the office portion of the room.
Business furniture includes anything that you use for your business, such as standard office furniture like a desk and chair. Depending on your business, it could include other items as well—for example, a psychologist might need a couch, an artist might need work tables and easels, and a consultant might need a seating area to meet with clients.
One court held that a financial planner was entitled to have a television in his home office because he used it to keep up on financial news. Be careful what you put in this space, however. In another case, the IRS disallowed the deduction for a doctor because he had a television in the part of his living room that he claimed as his home office. The court wouldn’t buy the doctor’s claim that he only watched medical programs.
As the public relations professional’s case shows, so long as you regularly use a dedicated space for your home office, the fact that you may have to pass through that space to get to other portions of your apartment will not disqualify you for the home office deduction.
For more information on this and other tax issues for small businesses, get Deduct It! Lower Your Small Business Taxes, by Stephen Fishman (Nolo).
If you need more help, talk to a tax professional, such as a certified public accountant or a tax attorney. A tax professional can prepare tax returns or provide tax information, guidance, or representation before the IRS.
]]>However, your business must earn a profit to actually take the deduction.
What constitutes a “home” for purposes of the home office deduction is broadly construed. It includes a regular house, apartment, condominium, or mobile home, or even a boat in which you live. But what about an RV (recreational vehicle)?
The two main IRS rules for deducting home office expenses are:
In a case that ended up in tax court, the court said no. The case involved a couple who paid $283,494 for an RV back in 2002. The RV was relatively large: It had a sleeping area, a bathroom, and a kitchenette with a countertop. Across the vehicle from the kitchen counter was a second countertop that the husband used as a desk and on which he had a computer and office supplies.
The couple operated a consulting business together. They had a home in Illinois but spent half of 2005 and all of 2006 traveling in their RV. They worked at their business while they traveled. They claimed a home office deduction of almost $6,000 for 2005 and over $9,000 for 2006. The IRS denied both deductions, and the tax court agreed.
To qualify for a home office deduction, a business owner must use a portion of a dwelling unit regularly and exclusively for business purposes. The tax court found that this couple had failed to prove that there was an identifiable portion of their RV that was used exclusively for business purposes.
The area they claimed constituted the home office was the countertop that the husband used as a desk. But the court said it was simply not believable that “in the cramped quarters of a motor home, an unclosed area like the countertop would somehow be exclusively reserved to business activity.” (Dunford v. Comm’r, T.C. Memo 2013-189).
This was not the first time a taxpayer with a small living space was denied a home office deduction. A psychologist who lived in San Francisco claimed a home office deduction for one-quarter of her apartment. However, the entire apartment was a 400-square-foot studio consisting of an open area (approximately 13 feet by 15 feet) furnished with a desk and a couch and a small dining area and kitchen (each approximately 7 feet by 8 feet).
Given the layout of this tiny apartment, the court wouldn’t buy the taxpayer’s claim that she used 100 square feet exclusively for business. (Mullin v. Comm’r, TC Memo 2001-121).
In theory, you might be able to take the home office deduction for an RV if you can meet both the regular use and exclusivity tests (and otherwise qualify), which is tough to do when dealing with the limited available space in an RV. While you might use a specific area of your RV as your primary office, you probably don't use it exclusively, especially if you also also live in it. For guidance on this and other tax matters, talk to a tax professional, such as a certified public accountant or a tax attorney.
For more information on deductions and other tax issues for small businesses, get Deduct It! Lower Your Small Business Taxes, by Stephen Fishman (Nolo).
]]>The home office deduction is available to renters and homeowners alike. It is available for office space and other areas you use for business in your home; such as a studio, workshop, or garage. And according to the IRS, your "home" can be a house, condo, or apartment unit—or even a mobile home or boat, as long as you can cook and sleep there. However, you must meet two tax law requirements to qualify for the home office deduction:
Requirement #1: Regular and exclusive use. You must regularly use part of your home exclusively for a trade or business.
Requirement #2: Principal place of business. You must also be able to show that you use your home as your principal place of business. Alternatively, you must be able to show at least one of the following:
We'll explain these requirements in turn below. For information on a simplified home office deduction for deductions under $1,500 per year, see The Simplified Home Office Deduction.
Ordinary business expenses are deductible even if you don't qualify for the home office deduction. If you don't meet the rules above, you can still deduct ordinary and necessary business expenses that you incur at home—for instance, long-distance phone calls, a separate business telephone line, and the cost of office supplies and equipment. The above IRS rules apply only to the expenses of actually running and maintaining your home, such as utilities, rent, depreciation, home insurance, mortgage interest, real estate taxes, and repairs.
To take deductions for home-related expenses, you must regularly use part of your home exclusively for your trade or business.
Regular use. The IRS doesn't offer a clear definition of regular use—only that you must use a part of your home for business on a continuing basis, not just for occasional or incidental business. You can probably meet this test by working a couple of days a week from home, or a few hours each day.
Exclusive use. Exclusive use means that you use a portion of your home only for business. If you use a room of your home for your business and also for personal purposes, you don't meet the exclusive use test. However, you can set aside a portion of a larger room to be used only for business, as long as your personal activities don't stray into it.
Brook, a lawyer, uses a den in his home to write legal briefs and prepare contracts. He also uses the den for poker games and hosting a book club. Because he uses the den for both business and pleasure, Brook can't claim business deductions for using the den.
Marvin has a den he uses only for business. He also puts a business calendar, desk, and computer in his kitchen, but continues to cook and eat there as well. Marvin can claim business deductions for the den, but not the kitchen.
There are two exceptions to the exclusive use rule: You don't have to meet the exclusive use test if you use part of your home to store inventory or product samples, or if you run a qualified day care facility at your home. (The storage exception is discussed just below. For the day care rules, check IRS Publication 587, Business Use of Your Home, at www.irs.gov.)
Storing inventory or product samples at home. If you store inventory or samples at home, you can deduct expenses for the business use of your home, whether or not you use the storage space exclusively for business.
There are two limitations, however: First, you won't qualify for the deduction if you have an office or other business location outside of your home. Second, you have to store the products in a particular place—your garage, for example, or a closet or bedroom. It's okay to use the storage space for other purposes as well, as long as you regularly use it for storing inventory or samples.
Jim sells heating and air conditioning filters to small businesses. His home is the only fixed location of his business. Jim regularly stores his inventory of filters in half of his basement. He sometimes uses the same area for working on his racing bikes. Jim can deduct the expenses for the storage space, even though he doesn't use that part of his basement exclusively for business.
Finally, the home office deduction is available only if you are running a bona fide business. If the IRS decides that you are indulging a hobby rather than trying to earn a profit, it won't let you take the home office deduction. For information that will help you prove that you're really running a business, see How to Prove Your Hobby Is a Business.
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