The COVID-19 pandemic has taken the world by storm and has accelerated a direction in which many businesses were already heading to - remote work. Because of this, many people have turned a portion of their home a dedicated space for work - aka created a home office. I know what you're thinking - work-life balance is so 2019. There are some benefits in the form of tax deductions that you can claim, however, and we're diving into the nuances of the home office deduction below.
First let's dive into what exactly qualifies as a home office: an area in your home that is regularly and exclusively used for business purposes.This means that Your home office has to be either a separate room or have a clear separation from your personal living space. NOTE: The IRS doesn't have clear guidelines regarding what counts as "separation," but it mentions that a partition is not necessary. Another stipulation is that it must be consistently used - you'd don't always have to work from it, but it also cannot be used only once a month either. Last stipulatio, and certainly not least you must use your home office to meet with clients on an ongoing basis or carry out a good amount of administrative and management tasks from it. The following activities are some, but not all, of the administrative tasks that should be carried out:
- Having virtual meetings with clients, vendors or team members
- Checking your email, answering phone and following up with leads, clients or appointments
- Continuing Education or preparing for a license examination
Now that we know what qualifies as a home office expense, let's dive into how you go about claiming it a receiving a tex deduction.
The IRS Form 8829, known as the “Expenses for Business Use of Your Home,” is the tax form you use to claim your home office deduction. This form applies to anyone who takes the standard home office deduction, and you file it with your annual tax return. The information from this form appears on Line 30 of the Schedule C.
NOTE: If you’re using the simplified method for the home office deduction (which allows you to take a standard deduction of $5 per square foot of your home office, up to 300 square feet), you don’t need to fill out Form 8829. Instead, you just claim the amount on your federal income tax return.
Diving deeper, you can deduct direct home office expenses and indirect home office expenses. What's the difference and how are they treated? Let's see below:
- Direct home office expenses are fully deductible and are only related to your home office space, like repairs to your desk or a new office chair. In essence, you don’t share them with the rest of your living space. Because these expenses are directly related to your home office, you treat them like any other business expense.
- Indirect home office expenses are expenses that you incur for your entire home. You’ll write these expenses off as a percentage based on the percentage of your home that you use for business.
- Some examples of indirect home expenses are:
- Homeowners or renters insurance
- HOA fees
- Mortgage Interest (please see note below)
- Proptery taxes (please see note below)
- Repairs and maintenance made to your entire home (roofing, windows, etc)
- Security system
- House cleaning
- Utilities (like gas, electric, and trash)
- Some examples of indirect home expenses are:
You can write off your entire mortgage interest and property tax as an itemized personal deduction or you can write off the business percentage as a home office expense and take the rest as a personal deduction. Why would you want to do this? To decrease your business income tax.
Before your eyes gloss over, stay with me. I promise it's worth it, and this can save you a lot of money every year. When discussing indirect home office expenses, we mentioned that you can write off a percentage of it. Here's how to determine that percentage:
- Measure the total square footage of your home. You should be able to find this in your mortgage documents.
- Measure the square footage of your home office space.
- Divide your home office square footage by your total home square footage. The total is the deductible percentage.
For example: let's say your home is 1,000 square feet and your home office is 200 feet. This would mean you could write off 20% of the indirect home office expenses.
VERY IMPORTANT NOTE: You must have a positive net income aka a profit to claim the deduction. If your business’s net income is negative, you can’t claim the home office deduction to increase said loss. On the same token, you can only take the home office deduction up to your total net business income—you can’t use the home office deduction to create a loss in your business.
This can seem like a lot, but writing off your home office isn’t so complicated especially when you're planning things out ahead of time. As a business owner, you make business decisions that impact your tax liability 365 days out of the year. Waiting until April 15th to do some "creative accounting" simply won't cut it. That's why here at Club Capital, we encourage agents to be strategic with their finances and sign up for tax planning to design a strategy to efficientely decrease their tax liability. For more information, please reach out to email@example.com.