Claiming a Home Office
My wife has had a home office for a couple of years, and I’ll have one for 2012. Since we’re both independent contractors, that means we can deduct some of the money we spend on our home against our business income. If we leased office space outside of our home, clearly all of the costs related to that space would be fully deductible as a business expense. So it’s perfectly legitimate—which is not to say easily done—to deduct home office expenses.
Is Claiming a Home Office Worth the Trouble and Risk?
As we all know, tax record keeping is a major pain in the posterior. Though software programs make the filing process much easier, before resolving to claim a home office, I suggest you first make a ‘quick & dirty’ estimate of how much tax you might save by claiming home office expenses. Also, though this is tough to do, try somehow to consider the intangible factor that claiming a home office boosts the chances of an IRS audit. About 1.1% of all tax returns were audited last year; I’ve not been able to find numbers (help anyone?) on the audit rate among those claiming a home office, but all sources agree that deducting home office expenses is roughly tantamount to blasting an air horn in the lobby of IRS headquarters. You’ll get some attention.
Let’s say your status is Married Filing Jointly and your household 2011 adjusted gross income is $65,000. For 2011, you’re in the 15% marginal tax bracket. That means every $1 you deduct will knock 15 cents off of your income tax bill. After you read through the rest of this post, look up a few 2011 household expense numbers, and locate a tape measure, you’ll be able to do a back-of-the-envelope estimate of the grand total home office deduction you could claim.
Let’s say you come up with $3,000 in deductible home office expense. If you make this deduction you’ll save
→ $3,000 x 0.15 = $450 in tax
Now, here’s where people divide according to philosophy. Some, almost as a matter of principle, claim every deductible cent they can, regardless of the personal hassle or possible consequences. Others hate so much the process of doing taxes and keeping records they keep their return as simple as they can, even knowing their approach is costing them money.
I take a practical approach. I wouldn’t (and won’t) claim a home office to save $450 in tax, for these reasons:
- I can, if I choose, earn more than $450 if I devote to my business the time it would take me to keep and organize records to support a home office claim.
- Our taxes are complicated, so we pay to get our returns done. Part of the $450 benefit would be offset by an increase in our tax preparer’s fee to do the home office part of our return.
- I’m cynical enough to think that if I’m audited (which, again, is more likely if I claim a home office), no matter how diligent I’ve been about my tax returns, the IRS is not going to rest until it’s at least paid for the audit and made a bit of profit. I suspect that would work out to be considerably more than a $450 hit.
For me, I think I’d have to see a tax savings benefit in four figures before I’d claim a home office. You may judge differently.
Do You Qualify?
Before you spend a lot of time collecting records, first determine whether you’re eligible to deduct home office expenses. The IRS has prepared this handy and uncharacteristically penetrable flowchart to help with just that question.
I call your attention to a key box in this graphic: “Is the use [of the alleged office space in your home] regular and exclusive?” Regular—what does that mean? Every day? Surely not. Once a month? Doubtful. One day a week? A few times a week? No one knows, which is one reason home office returns are fertile audit ground.
What about “exclusive”? I can’t speak for the IRS’ esteemed wordsmiths, but to me, exclusive means the space is used only as your office and nothing else. That feels like a pretty high hurdle. But how would the IRS know how you use the space you’re considering claiming? They wouldn’t, unless you tell them or someone rats you out through IRS Form 3949 A, benignly labelled “Information Referral” but which is used to report “alleged violation of income tax law,” including “false deductions.” Just one more reason to stay on good terms with your spouse.
If you’re serious about claiming a home office and if you do your own taxes, download the 34-page IRS Publication 587, “Business Use of Your Home” and keep it on your nightstand, along with a big bottle of ibuprofen.
There are far more details in Publication 587 than can be explored in one or several blog posts, but here are some essentials:
- The portion of qualifying home expenses you can deduct is based on the percentage of your home’s total floor space that’s dedicated to your office. So if your office comprises 150 square feet in a 2,400 square foot home, you can deduct 6.25% of qualifying home expenses (150 ÷ 2,400 = 0.0625).
- If your home-based business lost money, the deductions for some expenses are limited. Here’s an excerpt from Publication 587:
If your gross income from the business use of your home is less than your total business expenses, your deduction for certain expenses for the business use of your home is limited.
- The business part of expenses you could deduct even if you did not use your home for business (such as mortgage interest, real estate taxes, and casualty and theft losses that are allowable as itemized deductions on Schedule A (Form 1040)). These expenses are discussed in detail under Deducting Expenses, later.
- The business expenses that relate to the business activity in the home (for example, business phone, supplies, and depreciation on equipment), but not to the use of the home itself.
Your deduction of otherwise nondeductible expenses, such as insurance, utilities, and depreciation (with depreciation taken last), that are allocable to the business, is limited to the gross income from the business use of your home minus the sum of the following.
Allocable—that’s a word rarely used outside of Washington, D.C. And after trying to comprehend the above, you may now understand why I suggested the ibuprofen.
- Direct expenses—say you paint your exclusive office space—are fully deductible.
- Indirect expenses like insurance, utilities, rent, real estate taxes, mortgage interest, and repairs are deductible in proportion to the floorspace percentage described above.
- If you tend toward masochism, you can also claim a depreciation deduction.
Get Some Help
If you’re serious about claiming a home office, unless you have a lot of time allocable to studying IRS publications, hiring a professional tax preparer is probably wise.
Do you claim a home office? How much tax do you save as a result? Or, if you’ve made a decision not to claim a legitimate home office, why?