By Christine Hannemann
COVID-19 has impacted many aspects of daily life. On a personal level, wearing masks, social distancing, Zoom weddings or rediscovering the concept of a “staycation” has made 2020 a year to remember.
Changes have impacted the workplace dramatically, as well. Many see an increasing trend toward remote work options and policies. Some predict an estimate of 25 percent to 30 percent of the workforce will be working from home multiple days a week by the end of 2021.
Many employees working from home for the first time may be looking forward to claiming a home office tax deduction but will find challenges in doing so under current tax laws. In contrast, self-employed individuals may be able to make the most of this deduction. Let’s take a minute to review the current law.
Employee vs. Self-Employed
Anyone who is paid a wage reported on a W-2 is considered an employee. In the past, employees who worked at home for the convenience of their employer had the potential to use their home office expenses as a deduction if they met certain criteria. The Tax Cut and Jobs Act (TCJA) eliminated the deduction for years 2018 through 2025, along with all miscellaneous itemized deductions. Maybe employees have upgraded their Internet, bought a more comfortable chair, or are running their air conditioning all day as a result of working from home. These may seem like legitimate home office deductions, but under the TCJA, none of the additional expenses are tax-deductible.
In contrast, a self-employed individual or independent contractor who receives compensation on a 1099 and runs the business as a sole proprietor is still allowed to take a home office deduction on their tax return if they meet the criteria. This group includes real estate agents, developers, attorneys, accountants, doctors, dentists, consultants and entrepreneurs. The deduction is restrictive, so it is important to understand the requirements.
Home Office Deduction Requirements
• Principal place of business: The taxpayer must regularly use the home office as their principal place of business. If a professional uses office space to meet clients but then returns home for administrative tasks, this would not qualify as the principal place of business.
• Use the home office exclusively for business: This is often referred to as the exclusive-use test. Space used for both personal and business projects would not qualify.
With so many workers now conducting business remotely, they may unexpectedly be sharing an office with family members. It is important to recognize that multi-purpose space such as the kitchen table, dining room or guest room may not meet the criteria. For example, an office that converts to the guest room, or an office used 9 a.m. to 5 p.m. for business purposes but after 5 p.m. is used for online schooling, would not qualify. This does not mean an entire room needs to be devoted to business use, but the space within the room must be exclusively used for business. Exceptions to this test exist, such as an in-home daycare, but the exceptions are limited. If a business owner intends to take the home office deduction, it is important to be aware of the exclusive use test and organize the office space to meet the criteria.
Regular or Simplified Method
Once the first two criteria are met, then a method must be chosen. The regular method has been a customary business deduction for decades, but in 2013 a simplified method was introduced to reduce the burden on small-business owners. Both methods base the calculation on the square footage of the home used for the business. The simplified method uses a standard of $5 per square foot to a maximum of 300 square feet. Under the simplified method, there is no depreciation to track nor later recapture, and limits to the home gain exclusion when the home is sold. The regular method will allow a deduction of home office expenses proportionately based on the home’s total square footage.
One advantage of the regular method is that indirect expenses would be allocated and often include utility bills, Internet service, insurance, property tax and home mortgage interest. This may also include home repairs such as repairs to the HVAC system or painting of the home. With the extra wear and tear on the home due to home office activity, there is a trade- off with the extra burden to track the expenses. The burden to track these expenses annually would include keeping receipts and maintaining an accurate record.
One of the biggest advantages of the simplified method is upon the sale of the home. “Depreciation recapture” is the gain received from the sale of depreciable capital property that must be reported as income in the year of the sale. Again, this may seem like a burden to track if the home is sold long after the deduction was taken as a home office expense. Under the simplified method there is no depreciation recapture.
Evaluating the facts and circumstances would help determine the most beneficial method to compute the home office deduction.
The method chosen can flip-flop from one year to the next, but once determined must be used for the entire year. The FAQs produced by the IRS are also helpful and can be found online.
Christine Hannemann is a Certified Public Accountant at Squire & Co.