There are a lot of IRS rules regarding deductions of home office expenses, so taking the time to understand and navigate them successfully can pay off for the telecommuter or home business owner.
When you look at your home office, it may appear full of home office deductions—equipment, furniture, shelving, etc.—all of which cost you a pretty penny. So if you qualify for a home office deduction, you are eager to deduct it all.
When figuring out which home office expenses are deductible, the IRS separates those less permanent items from the space itself. Furniture and equipment are deducted on a Schedule C if you are a home business owner or independent contractor. However, if you want to deduct the use of part of your home as a business expense, use IRS Form 8829 and read on to learn about what can be deducted.
Types of Home Office Deductible Expenses
There are two types of deductible home office expenses: direct and indirect expenses. Direct home office expenses relate to the actual workspace, so these include repairs and paint inside your home office, and are fully deductible. Indirect home office expenses relate to the house that the office is inside and are only partially deductible. Utilities and mortgage interest are examples of indirect expenses. Unrelated home expenses, such as lawn care or painting a room other than your office, are not deductible for your home office.
Calculating Indirect Expenses
To figure what portion of an indirect expense can be deducted, multiply the percentage of your home that is used for business by the amount of the expense. To calculate what percentage of your house is used for business, compare the size of your office to the size of your house using this formula:
Office Square Feet ÷ Total SF of home = Percentage of Business Use
All indirect expenses must be multiplied by the percent of business use, and if you began using your office during the tax year, all expenses must be prorated for the time you used the home office.
Direct vs. Indirect Deductible Expenses
Below are both direct and indirect home office expenses that can be deducted. Keeping up with these expenses throughout the year instead of trying to calculate them when it's tax time can save you a lot of time and limit errors.
Repairs (Direct and Indirect)
Repairs that are inside your home office are direct expenses and are fully deductible. For example, if you paint the walls of your office, the cost of the paint is a direct expense. However, you may not deduct the cost of your own labor. If you pay someone to paint, you may also deduct their labor as a direct expense. A repair to your furnace would be in indirect expense; though your furnace heats your home office, only the percent for business use is deductible.
Some repairs, like replacing the roof, could be considered improvements to your home, so you can't deduct them here. You can recapture by adding them to an adjusted basis of your home, which you use to calculate your deductible depreciation.
Real estate property taxes (Indirect)
Be careful not to deduct this twice. If you deduct a portion of your property taxes as part of your home office deduction, you must reduce the real estate taxes listed on your Schedule A by that amount.
Mortgage interest (Indirect)
As with real estate property taxes, be sure not to deduct mortgage interest twice. Deduct on Schedule A only the amount not already deducted on Form 8829. Mortgage insurance premiums may also be deducted depending on your income.
Multiply your rent payments by the percentage of business use of your home.
Multiply the cost of electricity, gas, trash removal, and cleaning services by your percentage of business use. Your telephone is not included in this because the first telephone line to your house is considered for personal use and is not deductible at all. However, a second line used exclusively for business is deductible but should not be included on Schedule C.
Homeowners or Renters Insurance (Indirect)
Be sure that you only deduct the portion that is for the tax year that you are filing. Premiums are typically paid annually, so they might cover other years.
If you own your home, you can take a deduction for depreciation of the part of your home used for business. Depreciation is an allowance for the wear and tear on your home, so you cannot depreciate the value of the land.
Depreciation is calculated by multiplying the adjusted basis of your home (its cost plus any permanent improvements) or the fair market value of your home when you began using it for business—whichever is less—by the percentage of business use and then by another percentage supplied by the IRS.
Taking a deduction for depreciation can have tax consequences when you sell your home later, so be sure to carefully consider whether a home office deduction is right for you. Depreciation is a complicated deduction with many special rules, so see IRS Publication 587 or consult a tax specialist for more information.