- Roughly 40% of American workers are operating completely from home.
- To qualify for a deduction, home offices must be consistently and exclusively used as a principal place of business.
- Both direct and indirect expenses qualify as tax-deductible.
- Taxpayers can choose between the Regular and the Simplified methods for calculating their final home office deduction.
It’s safe to say that the pandemic has been a bit of an adjustment for American workers. As 40% of the country works from home, bored kids, ill-timed delivery drivers, and noisy neighbors threaten to derail key stretches of productivity. Fortunately, many professionals have a dedicated in-home workspace that keeps household disturbances at bay. What many of these people don’t realize, though, is that their home office can also mean a significant break on their taxes. We’re here to help you determine whether your home office qualifies for a tax deduction, and exactly how much it could save you.
What Is The Home Office Deduction?
This is a tax break that allows you to take the cost of creating, improving, and/or maintaining your home office as a deduction on your yearly returns. If you’re employed by a business, then it’s a Schedule A deduction; so you’ll have to forfeit the standard tax deduction and itemize, instead. If you’re self-employed, this counts as a Schedule C deduction, which preserves the standard tax deduction. As long as the revenue from your business exceeds your deductions, then all business expenses qualify as tax-deductible.
How Do I Know If My Work-From-Home Situation Qualifies For A Deduction?
All types of homes are eligible for the break, whether you rent or buy. The question is, does your particular in-home workspace—and the way you use it—meet the criteria to make it a true home office? First, eligible home offices must be used exclusively and consistently for professional activities. This means that the space cannot serve anything but business ends and that it fulfills this function on a constant basis.
Second, although there are a couple of exceptions (we’ll get to those), the home office must be your principal place of business. This means it’s the main hub from which you conduct your professional activities. Not everything has to occur in your home office, but there can be no other fixed location for your business activities where you spend a significant amount of time. It’s also fine to work in other places, as long as you reserve administrative and management duties for your office space. There are, however, a few convenient exceptions to these rules:
- If your main workstation is not at home, but you have a dedicated place in your house where you receive clients, patients, or customers.
- If you technically have a workspace in an office, like a cubicle with your name on it that could theoretically serve as your principal place of business, but you choose to conduct your business activities in your home.
- If you have a free-standing structure, like a shed or a studio, that’s completely devoted to your work, even if you don’t spend the majority of your workday inside that structure.
How Do I Calculate My Home Office Deduction?
There are two avenues for arriving at your home office tax break: The Regular Method and the Simplified Option.
The regular method
Before 2013, everyone used the Regular Method, which requires that you specifically determine the “actual expenses” related to one’s home office. Deductible expenses fall into one of two categories: direct or indirect.
Direct expenses are those that pertain only to the business section of your home. These could include the building materials you used to create your home office (labor costs are not deductible), paint for your office, lighting improvements, etc. These expenses are easy to identify and compute (as long as you saved your receipts!) because they relate only to the workplace itself. And they are particularly pertinent in 2020, as many have spent over $600 hurriedly transforming a part of their home into a workstation.
Indirect expenses are those general repairs and maintenance efforts that apply to the entire home but keep your office running by extension. Roof repairs, heating improvements, insurance, and utilities all count as tax-deductible indirect expenses. However, you can only apply a fraction of what you pay for them as part of your home office deduction.
Whatever percentage of your home the office occupies is the percentage that you can deduct for indirect expenses. For instance, if your home office takes up 20% of your home, then you can only take 20% of your utility bill as a deduction. In order to calculate this percentage, you’ll need to know exactly how much square footage your office occupies within your home’s overall floor plan. If your office takes up 300 sq ft. of a 3,000 sq. foot home, then it comprises 10% of the overall square footage.
Probably the most convoluted of these indirect expenses is depreciation. Depreciation allows for deductions that cover a home office’s normal wear and tear. Calculating these deductions requires that you know the time you started using your home for business, your home’s fair market value, its adjusted basis, and improvement costs (before and after using it for business). Basically, you multiply the percentage of your home occupied by your office by either the adjusted basis or fair market value (whichever is lowest). Then you multiply that by the depreciation percentage that corresponds with the month you started using your home as a business hub. Those depreciation percentages can be found here. It’s important to note that from year to year, your property’s adjusted basis needs to reflect the depreciation experienced the previous year. Otherwise, you won’t be using an accurate representation of your property’s value over time.
Once you’ve added up all these expenses, they form your actual home office expenses; and while computing them can feel like a hassle, the tax write-off is often worth a little extra math.
The simplified option
This relatively new approach to securing the home office deduction streamlines the method for calculating your final home office write-off. It works like this: for every square foot of your dedicated office space, you receive a $5 tax deduction. For example, a 200 square foot office space, at $5 per square foot, garners a deduction of $1000. In exchange for this simplicity, you’ll have to make a few sacrifices. Even self-employed individuals who choose this option must itemize on their tax returns. The simplified option also doesn’t include a depreciation deduction, nor the option to recoup a home’s depreciation upon its sale. Many still choose it, however, because it’s an easy path to a considerable deduction.
Thankfully, choosing one of these options only locks you into a calculation method for that year of taxes. You can switch back the next cycle, just remember when switching from simplified to regular that you need to recalculate depreciation using the most current values for your property.
Now that you know what qualifies as a home office, which expenses are tax-deductible, and how to calculate your write-off, you’re equipped to take on your taxes, and one step closer to making your work-from-home environment work for you.