I often get asked “Do I qualify for the home office deduction? by my tax planning clients. Are you self-employed or a small business owner?  If you work from home you may be able to take the home office deduction.  Here is what you need to know to figure out if you qualify and get a better understanding of how this often-scary tax deduction works. You shouldn’t feel afraid to take the home office deduction if you are entitled to it.  Keep reading to answer the question, do I qualify for the home office tax deduction?

Update: Have you found yourself working from Home during COVID? If you only earn W-2 income you are not eligible to take a deduction for a home office. (Thanks to the Trump Tax Plan.  For those with a side hustle or even just a little self-employment income keep reading. The home office deduction may help you save some money on taxes. Who doesn’t love paying fewer taxes, am I right?

The home office deduction has a reputation for being an audit red flag.  While this may be true in some cases, you have nothing to worry about if you have good records and actually qualify for the deduction.

Working from home sure has its benefits.  You can’t beat the commute and you might have more time to spend with your family.  The cherry on top may be some extra money in your pocket from not having to pay for an office and from a potential tax deduction.

Growing numbers of solopreneurs and small business owners working from home have made the home office deduction an even more important topic for you to understand.   I’ve spoken with many business owners over the years who are likely eligible for this tax break but don’t take it.  Why?  Because they are just afraid of any undue scrutiny of their tax returns.

Tax law is complex and, with the new GOP tax plan, things are not going to get any easier for the self-employed.  The record-keeping hassles of the home office deduction have scared many away over the years.  Also, there is a depreciation recapture provision that could mean higher taxes if you sold your home after taking the home office deduction.

Whatever your situation or reason for not taking this deduction in the past, you may benefit from better understanding this portion of the tax code.   I think if more people know how much this deduction might actually lower their tax bills, their fears might quickly recede.  The following information will give you a basic understanding and a simpler way to take the home office deduction.

If you live in an expensive area like Los Angeles, Palm Springs or San Francisco- the home office deduction can be a huge tax saver.  As the gay financial advisor– many of my clients live in expensive parts of the country, and many benefit from this valuable tax break.

According to a new study, 45% of remote employees work regularly from a couch, 38% from their bed, 20% work outdoors, and 19% in a closet.–Axios, July 29, 2021 –NOTE: Most of these work from home scenarios would likely not qualify for the home office deductions.

Related: Los Angeles Tax Planning Financial Advisor

What will qualify for a tax deduction as a home office?

The biggest thing you should know is the space you work in should be used “exclusively and regularly” as your principal place of business.  OR it should generally be used exclusively and regularly as “a place where you meet or deal with patients, clients or customers in the normal course” of your business.  This is according to IRS Publication 587.

The “exclusive use” may vary slightly for businesses but your living room couch, in front of the TV, will likely never qualify.  That is unless you get paid to literally watch TV or you are a professional gamer of some sort.

What if my home office is not in a separate room?

The home office can be either a “room or separately identifiable space.”  This space doesn’t have to be marked off by a permanent division of some kind.  Of course, the space should look like an office or workspace.  A room with a closet full of clothes or kids’ toys likely doesn’t relate to your business.  On the other hand, a desk and computer in the corner of your living room might very well be your principal place of business.

What do you mean by principal place of business?

Many businesses have multiple locations and some business owners work on their laptops from various Starbucks locations throughout the year.  For the home office deduction to apply, your home must be your principal place of business for that trade or business.

To help figure out if your home is the principal place of business, consider the relative importance of your various activities and where they are done.  For your home office to pass the “principal place of business” test, you must use it exclusively for “administrative or management activities” and you must not have any other location where you also conduct a substantial amount of “administrative or management activities.”

What does used “regularly” for business mean?

This tends to be one of the more confusing parts of the home office deduction.  The IRS really doesn’t offer that much guidance in this area.  What they do say is that “incidental or occasional” business use is not enough.  In the event of an audit, auditors will likely base their decision on the circumstance of each business.  The more questionable the deduction, the more you need to make sure you have better records.

Can employees claim the home office deduction?

For 2018 through 2025, company employees who work from home won’t be able to deduct any home office expenses.  Why?  The Tax Cuts and Jobs Act (TCJA) suspends miscellaneous itemized deductions subject to the 2% floor for this period.  I know this one is really riling up many of my entertainment industry clients here in Los Angeles.  One thing to mention, this does not apply to self-employed individuals who work from home.  As a business owner, you may still be able to deduct home office expenses.

Will the home office deduction increase my chances of being audited?

The audit risk from the home office deduction is likely an urban myth or at least a bit exaggerated.   While the IRS does report the number of audits it undertakes, it doesn’t specifically disclose how many might involve the home office deduction.  I’d imagine the tax hit can be substantial for those who get audited and don’t actually qualify for the deduction. The bigger the tax headache the more likely you are to hear someone complain about it.  It’s never fun to be audited or get a big tax bill.  Of course, if you qualify for the deduction you likely shouldn’t take it.

The new, simpler way to take the home office deduction

Starting in 2013 taxpayers had a simpler option when taking the home office deduction.  Here is how it basically works for most people.  Multiply the square footage used for the business at home (capped at 300 square feet) by $5.  According to the IRS, this collectively saves filers 1.6 million hours in paperwork and recordkeeping each and every year.

While the simpler version may save you time, it may end up costing you money.  If you live in an expensive place or use more than 300 square feet for your office, it is worth at least checking to see if the “old” method will save you more money.  To put that in perspective, if you live in a 2,000-square-foot house and use 300 square feet for business, you would only need to spend $10,000 or more, per year, on your home and utilities to beat the new deduction using your actual numbers.  Spending that little would be nearly impossible in most large cities, so take the time to crunch the numbers.

For many of you reading this, a home office can potentially save you thousands of dollars in taxes each and every year.  With that much money on the line, I think a conversation with your accountant and fun financial planner is a great use of time.  Don’t let a little extra record-keeping prevent you from minimizing your tax bill.  After all, it’s not what you make but what you keep.

If you are looking for more tax savings, check out the Solo 401(k) and the Cash Balance Pension Plan, they could save you hundreds of thousands of dollars over the next few years. 

Live for Today, and Plan for Tomorrow!  Paying less in taxes means more money in your pocket!

DAVID RAE, CFP®, AIF® is a Los Angeles Certified Financial Planner with DRM Wealth Management.  A regular contributor to Forbes.com,  Advocate Magazine, Huffington Post, and Investopedia not to mention numerous TV appearances.  He helps smart people across the USA get on track for their financial goals.  For more information visit his website at www.davidraefp.com

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