Claiming a Home Office

Apr 4, 2012 by

claiming a home office

Outdoor Home Office by OfficePOD

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.

Excerpt from 2011 IRS Publication 587, “Business Use of Your Home”

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.

What’s Deductible

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.

  1. 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.
  2. 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?

  • Thanks for these detailed explanations. This is helpful. I agree with you on the “practical” approach. Like with everything in business, you should focus on those activities that are worth your time.

    • Thanks for your comment. Yes, as we all know, life is short, and time spent ‘engaging’ the IRS can be especially wasteful, not to mention frustrating!

  • That is a very thorough explanation of home office deductions. But, I agree with looking for help in navigating IRS.

    • Thanks Marissa, I appreciate your visit to Money Counselor!

  • Onecentatatime

    this is very informative. Thanks for putting together

  • We just finished our taxes yesterday and claiming an office was on there. Thank goodness for Google and PDF’s. We found the calculation formula and figured out what we could claim. Now that we have done it once we will be better off next year. 

    • Good for you! I hope the extra effort pays off in significant tax savings for you!

  • My qualifying space works out to 10% of our home so that is what we claim.

    Are you still following US tax rules even though you are in Canada?

    • With respect to my own tax returns, as a U.S. Citizen/Canadian Permanent Resident living in Canada, I follow CRA rules when completing my Canada tax return and IRS rules when completing my U.S. tax return. (U.S. citizens are required to file a U.S. tax return regardless of where they live.)

  • Sorry if my question was too personal. That certainly sounds like a lot of work come tax time every year.

    • No worries, and yes it’s too much work, or I should say expense! Too complicated for me to handle.

  • J K

    Additional complications of claiming a home office come when you sell your home.  That’s my situation and, frankly, although it’s not a huge amount of money either way, I wish I’d never claimed the home office.

    • Thanks for this info. Are the complications due to having taken depreciation?

      • J K

        Yes, that’s my understanding.  When I sell the house I will have to pay back some of the tax savings the home office deduction created for me over the last 5 years.  Since I prefer to keep my personal finances “checkbook simple” (i.e. no debt or outstanding bills) I don’t like the IOU to the IRS hanging over my head.

        In addition, since my home business is my only source of a small earned income, I try to get the earnings up enough to maximize my annual IRA contribution.  The home office deduction has, at times, reduced my earned income enough that I cannot make the maximum IRA contribution.  That’s another reason I wish I had not ever claimed it. 

        I wanted to drop it this year so I could contribute the maximum to my IRA but my tax adviser said the IRS might question why I had an home office for the previous 4 years and then had none this year but still had similar income.  It would appear I was trying to modify my tax situation to my advantage.  I did not do any research to see how true this might be – I just claimed the home office again this year.  Since we’re moving later this year I definitely won’t claim it for tax year 2012.

        I’m no tax or financial guru so anyone reading this should consult a person with appropriate training and experience to know the precise and accurate details.

All original content on these pages is fingerprinted and certified by Digiprove