09/13/2020
6 Things to know for Home Office Deductions
By Andy Medici – Senior Staff Reporter, Washington Business Journal
Sep 10, 2020, 12:52pm EDT Updated Sep 10, 2020, 5:27pm EDT
The spread of Covid-19 across America caused countless people to work from home and small-business owners to turn parts of their living spaces into workspaces and wall areas into Zoom backgrounds. And yet, for many of those folks, claiming the home office tax deduction is still not a slam dunk.
“If you work out of your home, you're part of a growing trend,” said Mike Savage, CEO of virtual accounting firm 1-800Accountant.com, based in New York. “What's important to you, however, is that you may qualify for some valuable federal income tax deductions.”
The home office deduction is one of them. But experts say there is a big caveat: Traditional workers without self-employment income effectively cannot qualify.
That means employees whose sole source of income comes from a job that yields them a W-2 form at the end of the year can't take the deduction even if they create a dedicated home office. For those workers, that prospect was eliminated as part of the Tax Cuts and Jobs Act passed in December 2017.
“It used to be that you had an itemized deduction for unreimbursed business expenses. It used to be that if I spent money for the firm and I wasn’t reimbursed, I would take a deduction. Those got eliminated in 2017,” said Richard Morris, director of tax services at accounting and advisory firm Councilor, Buchanan & Mitchell PC.
On the other hand, those who earn self-employment income — whether it's freelancers, business owners, law firm partners or others — will most likely qualify for the deduction.
"The people who can avail themselves of it? Absolutely. I think it’s going to be huge," Morris said.
But even for those individuals, experts suggest these six things to keep in mind when considering a home office tax deduction, in addition to consulting a tax professional:
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The office has to be “regular and exclusive.” That means the home office has to be in use on a continuing basis — not necessarily every day, but in a pattern that can be documented, Morris said. It also must be exclusively used for work, meaning a kitchen table couldn't qualify. “It’s not just for a long weekend,” Morris said. “The only time I am in there, I am doing work. It also can’t be you or your kid watching TV."
The size of the deduction can depend on the size of the home office. If it spans about 400 square feet out of a 2,400-square-foot home, then individuals can deduct that similar percentage off utilities, homeowner association dues, condo fees and other related expenses, Morris said. "It's a great deduction," Morris said. "If you own your property, you get to shift all the previously undeductible expenses into deductible expenses."
There is an option for a more simplified deduction, in which each square foot of the office is multiplied by $5, up to a maximum deduction of $1,500, according to Morris. That option makes it easier for the homeowner and the IRS alike.
This could come up if you sell your home. Normally a home's sale is exempt from capital gains tax up to a certain amount, but claiming the home office deduction could affect that, Savage said. "If you have taken depreciation deductions on the part of your home you use as an office, that amount will not qualify for the tax exemption you otherwise get on the gain from the sale of your house," Savage said. But there are options on recapturing that depreciation, and each person's situation could vary.
It won't be helpful to businesses that saw a loss in 2020. "If your business ran at a loss, you typically cannot take the deduction. But you may be able to carry forward the home office expenses and use it in the year you become profitable," Savage said.
Keep in mind that this could raise a potential red flag that might attract an auditor's attention, though experts disagree to what extent. Justin Follis, an accountant and shareholder in the tax division of audit, accounting and advisory firm LBMC PC in Knoxville, Tennessee, said that using the home office tax deduction on its own is not enough to flag a tax return, but it may count against the filer. “They take the tax return that is filed and they compare it to a model of a typical tax cheat,” Follis said. “What are high-risk positions or what are positions in a return that would add to the potential of abuse — and this has certainly been on their list for a long time.” Morris, however, said the IRS is much more focused on other issues, such as whether the business is a cash business — an area in which data has shown a higher likelihood of issues.
