HOME OFFICE - DEFINITION AND DEDUCTIBILITY
The home office provision has been in effect since the calendar year 1999 by the Taxpayer Relief Act of 1997 signed by President Bill Clinton. This act also implemented two other important provisions that have become so crucial especially during the pandemic: child tax credit and principal home capital gain exemption. The home office provision has become more robust and dynamic through the years. In order to somewhat relieve the burden, the IRS allowed a simplified approach starting the calendar year 2013. I will go into more details of the simplified approach in the next post; please stay tuned. This post means to give you the home office definition and what expenses you can reasonably expect to take as a deduction. Broadly speaking, there are a few criteria listed below to determine if business owners can claim the home office deductions.
Exclusively and regularly use as your principal place of business
Exclusively and regularly use as a place where you meet and deal with customers in the normal course of business
If you use a separate structure that is not attached to your home, the activity must be in connection with your trade or business
You notice that “exclusively” and “regularly” are used repeatedly. Let’s define those terms per IRS Publication 587:
Exclusive use means that you must use a specific area of your home only for your trade or business. The area used for business can be a room or other separately identifiable space; it does not have to be marked off by a permanent partition.
Here comes a kicker, if you use part of your home as storage of inventory or day-care facility, then you are exempt from the exclusive-use test.
Regular use means that you must use a specific area of your home for business on a regular basis; in other words, it won’t qualify if you use the space incidentally or occasionally.
Now that we are clear on what exclusive and regular use mean. Let’s tackle another important term “principal place of business”. Per Publication 587, in order to qualify as a principal place of business, you must meet the following requirements.
You use it exclusively and regularly for administrative or management activities of your trade or business
You have no other fixed location where you conduct substantial administrative or management activities of your trade or business
I hope you are not dizzy at this point but realize that you meet all of the aforementioned requirements. Let’s dive into the deductions; there are two categories: direct and indirect expenses.
Direct expenses: are deductible in full because they benefit the business portion of the home, e.g., repairs made specifically to the home office, separately billed utilities to the home office, etc.
Indirect expenses: are allocated between business use and personal use because they benefit the upkeep of the entire home, e.g., real estate taxes, mortgage interest, security systems, depreciation, etc.
The simplified formula for allocating indirect expenses is:
Area for home office / Total area of home = Business percentage
I hope this has been helpful. Stay tuned for the next post which we will go over depreciation, limitation, and simplified approach. Please reach out for any further questions. Thank you for visiting.
