When and Where Should You Take a Home Office Deduction? | USTaxAid

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When and Where Should You Take a Home Office Deduction?

Written by Diane Kennedy, CPA on November 12, 2021

In this blog we’re going to look at how to take the home office deduction. This is one of those deductions that many people skip because they think it’s an IRS red flag (no, it’s not) or that it’s complicated to deduct. It’s not that complicated, but it is important to deduct it in the right place. The right place all depends on what type of entity you have.

Let’s start off with when you can take a home office deduction. This all began with a question that I received at USTaxAid.com.

“Can I pay my boyfriend office rent and then he can claim using his RE as a rental? He needs to create a business and I thought this would be one way to do it.”

This is actually a trickier question then you might expect from the beginning. For example, do you live in the house where the office will be? If so, you have a home office and will need to follow the regular rules for home offices.

As far as your boyfriend, he could be a landlord under this situation. That means he would need to file a Schedule E. He doesn’t have a business. He would have passive investment property. If there is a loss, the amount of loss he can take against other income may be limited. He can depreciate the portion attributable to the office, but remember when he sells, he would need to recapture the depreciation and pay tax on it if he sells at a gain. 

Home Office Requirements

In order to take a deduction for a home office, the space must be “regularly and exclusively” used for the business.

You are considered to regularly use the space for your home office if you do work on a regular basis there. It doesn’t need to be your only office. You can work somewhere else. You can travel to client’s offices or homes and you still can have a home office.

Exclusivity means that you don’t share the same space. You can’t count the couch where you sit and watch TV because you sometimes answer  emails on your laptop there too. But you can divide up a space. We see that often in studio apartments or large basements or attics. If you can clearly define your home office and only do work there, you have a home office.

And there is one more requirement that is kind of a given. You have to have your home office in your home. 

How a Sole Proprietorship Deduct Home Office Expense

A Sole Proprietorship (Schedule C) take a deduction for the business use percentage of the home times indirect expenses. This includes single member LLCs that have not elected how they will be taxed. The default for businesses will be the Schedule C. 

Indirect expenses include home mortgage interest, insurance, utilities, property tax, repairs, maintenance and the like. Direct expenses are 100% deductible and include expenses directly for your home office expense. That might be painting the walls, adding floor coverings or changing a closet into a supply cabinet for the office.

Home office expenses are reported on Form 8829. One downside of the home office deduction for Schedule C businesses is that the expense cannot create a loss or bigger loss for your business. If it does, the home office expenses are suspended and rolled forward.

There is also a simplified method for Schedule C home offices that allows you to deduct $5 per square foot, up to $1500. However, if you have excess loss, you can’t roll it forward if you use this method.

Personally, I don’t like the simplified method. It’s simpler but it almost always means you leave money on the table. 

How a Partner Deducts Home Office Expenses

A partner is able to take unreimbursed partnership expense deductions as part of Schedule E (where you report partnership and S Corporation K-1 income/loss). It’s a separate line item, usually directly below the K-1.

A partner could also be reimbursed by the partnership for the home office expense.

The calculation is done in the same way with indirect expenses, business use % and direct expenses, but the calculation does not need to be disclosed in the same way. Simply make the calculation and either the partnership reimburses you for the costs (tax free to you and a tax deduction as rent for the partnership) or there is a separate line item for unreimbursed partnership expenses. 

Note that an S Corporation shareholder can’t take deductions in the same way. Only the partner (or member in a multi-member LLC with default taxation) can take the deduction that way. 

How a Shareholder Deducts Home Office Expenses

It gets more complicated for shareholder/employees who have home offices. An employee cannot take a deduction for a home office (Tax Cuts and Jobs Act). The corporation cannot pay the employee rent for use of a home office (IRS Code 280A (c) (6) ).

Instead, a corporation can set up a written accountable plan. An accountable plan is a plan that follows the IRS regulations for reimbursing workers for business expenses so that the reimbursement is not considered income. The reimbursements are not reported on the employee’s year-end Form W-2.  

The employee (you) must substantiate the payments within 60 days per the rules for accountable plans.

We will be covering accountable plans in more detail as part of the Wednesday Coaching classes.

 

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