It’s tax season, and you have probably already started to gather what you need to file your return this year. You have everything ready to go, and remember that you have been working from home since last March and ask yourself, “Can I claim a home office deduction?” This question likely hasn’t been on your mind until this year, and the pandemic’s onset.
Like most other tax questions, the answer is—it depends. If you are a W-2 employee, you cannot claim a home office deduction, even if you work from home full-time. This may go against your prior understanding, but with the passing of the Tax Cuts and Jobs Act (TCJA), effective for tax years 2018 through 2025, W-2 employees are no longer eligible for this deduction.
Before the TCJA, any unreimbursed employee business expenses, like home office expenses, could be a miscellaneous itemized deduction reported on Schedule A. TCJA eliminated miscellaneous itemized deductions and there have been no changes to this policy included in COVID-19 legislative relief.
Who Qualifies for the Home Office Deduction?
Sole proprietors and self-employed individuals are eligible to claim the deduction if a portion of their home is used exclusively and regularly as their principal place of business, defined as:
- Exclusive Use: A specific part of the home is for business purposes only. However, there is no requirement that the business portion of a room is physically separated from the rest of the room by a wall or partition. Any personal use of the space, no matter how small, fails the exclusive use, except in some instances for daycare facilities and businesses storing inventory. Working at the kitchen table likely wouldn’t qualify, but a desk in the living room used for business purposes only would meet the exclusive use requirement.
- Regular Use: The area is used for business on an ongoing basis. Occasional or incidental business use does not meet the regular use test, even if it is the area’s sole purpose.
- Used as Principal Place of Business: The home office must be used exclusively for administrative or management activities, and without substantial use of any other fixed location to conduct these activities. For example, a self-employed plumber traveling to job sites could still qualify for the home office deduction if they use an area of their home for scheduling, bookkeeping, and other business management.
Taxpayers that regularly meet with clients or customers physically in their home office—or whose home office is in a separate, unattached structure such as a studio, garage, or barn—will qualify for the home office deduction even if the home office is not their principal place of business.
What Can Be Deducted
Depending on what percentage of your home is used for your business, the following items may be eligible for a tax deduction:
- Mortgage interest
- Property taxes
- Home repairs/maintenance
- Travel between the home office and other work locations
- Direct expenses (for example, the cost of painting or repairing the home office can be deducted in full, and do not have to be allocated between business and personal use)
Establishing an Accountable Plan and COVID-19 Relief
With W-2 employees and shareholders ineligible for a home office deduction, employers can establish an accountable plan to reimburse employees/shareholders for expenses, and create a tax-free reimbursement opportunity for the individual. After meeting certain qualifications, the plan also creates a deductible expense for the employer.
Due to the COVID-19 pandemic, employers can reimburse employees for home office expenses under Qualified Disaster Relief, and still benefit from a deduction and tax-free income to employees without establishing an accountable plan. These home office expenses include monitors, printers, phones, office supplies, and desks. It’s crucial that employers document the amount of any such payments.
A partner may deduct home office expenses on their individual Form 1040 Schedule E if the partnership agreement states that a partner pays the expenses personally without reimbursement. Shareholders are ineligible for a home office deduction because TCJA eliminated the deduction for unreimbursed corporate expenses treated as unreimbursed “employee” business expenses.
How the Deduction Works
According to the IRS, there are two methods for calculating the home office deduction, and taxpayers can elect a different method every year:
|Simplified Option||Regular Method|
|Deduction for home office use of a portion of a residence allowed only if that portion is exclusively used on a regular basis for business purposes||Same|
|Allowable square footage of home use for business (not to exceed 300 square feet)||Percentage of home used for business|
|Standard $5 per square foot used to determine home business deduction||Actual expenses determined and records maintained|
|Home-related itemized deductions (mortgage interest, property taxes) claimed in full on Schedule A||Home-related itemized deductions apportioned between Schedule A and business schedule (Schedule C or Schedule F)|
|No depreciation deduction||Depreciation deduction for portion of home used for business|
|No recapture of depreciation upon sale of home||Recapture of depreciation on gain upon sale of home|
|Deduction cannot exceed gross income from business use of home less business expenses||Same|
|Amount in excess of gross income limitation may not be carried over||Amount in excess of gross income limitation may be carried over|
|Loss carryover from use of regular method in prior year may not be claimed||Loss carryover from use of regular method in prior year may be claimed if gross income test is met in current year|
|Method available if taxpayer rents home||Same|
Example – Simplified Method
Let’s say your home is 1,500 square feet, and you use 150 square feet as office space. $5 per square foot multiplied by 150 square feet of office space equals $750 deduction.
Example – Regular Method
Taking the same example with a 1,500-square-foot home and 150-square-foot office, you would use the equation 150/1,500 = 0.10 (10%)
|Expense||Annual Cost||% deductible||Amount deductible|
Preparing for Tax Season with Aldrich
With so much of the workforce currently working from home, knowing how and when to deduct home office expenses can feel overwhelming. If you have questions about implementing a reimbursement plan for your employees, or managing your home office expenses, reach out to your Aldrich Advisor.