Due to the pandemic, many employees have started working from home. It looks like this trend is very popular and will continue even after the pandemic is over. Of course, immediately the question comes to mind about tax deductions since working at home very often involves a separate room, new desk, possibly extra utilities, even unplanned repairs.
Good news for those who are considered to be independent contractors (note, it is irrelevant if you receive 1099 or not). All of the above-noted expenses plus many more are deductible.
How to deduct Home office expenses?
In order to take full advantage of this deduction, you will need to complete form 8829. You begin by calculating the area used as a home office. Simply measure your office or use a floor plan from your original purchase (it will have all the measurements you need). You will next measure your entire home, this will allow us to calculate a formula used in the tax return.
Let’s assume that the area of your office is 200 sq. ft. and the entire area of your home is 2,000 sq. ft. This gives us a formula of 10%, meaning that all related expenses will be deducted at a 10% rate.
Please note that the area used for home office deduction must be exclusive, this means that your son cannot play video games in that room, your daughter cannot do her homework, and if you have a pull-out couch in that room, your guests cannot sleep there.
As with everything related to taxes, there are always exemptions. In this case, an exception applies if you use a portion of your home for storage of inventory or product samples you sell in your business. In addition, a separate formula applies to daycare centers at home. However, due to the limitations of our article, today we will not focus on that topic.
The home office expenses: Direct and Indirect
All home office expenses will further need to be split into two categories:
Direct expenses are those that are 100% related to your home office and will be deducted at a rate of 100%. For example, if you had to install the door in your den to make it into the office, this expense is 100% deductible.
All other expenses, that do not only apply to your home office, but also to the entire house, will be considered indirect expenses and will be deducted at the calculated rate. The most common expenses are utilities, general home repairs, mortgage, insurance, property taxes.
In calculating the deductible amount of your home office, we will also take into consideration depreciation on your home. In order to calculate it, we will need to know how much is the original purchase price of your property plus any major capital improvements, and don’t forget to deduct the cost of land, as it is not deductible for our purposes.
If this method appears overly complicated, you are not alone. In order to simplify all of the calculations, the IRS has developed a special method that will allow foregoing all of the calculations above. This simplified method allows you to take $5 per sq. ft. up to 300 sq. ft. of your home office space used. Of course, if your home office is less than 300 sq.ft., you will you a much smaller deduction that represents the actual size of your office. This method does not require taxpayers to keep track of any expenses or calculate depreciation.
It is important to note, that although your home office doesn’t have to be your only place of business, it must be your principal. This means that if you visit your clients at their homes, all billing and appointments setting happens at your home office.
Tax Cuts and Jobs Act of 2017
Now to bad news, unfortunately, if you work as an employee of a company and receive W2, you cannot deduct home office expenses. Prior to 2018, this deduction was allowed even for W2 employees who used itemized deductions in their tax return, however, the Tax Cuts and Jobs Act (TCJA) has made significant changes to many aspects of tax law, including home office deduction. TCJA has completely eliminated the home office deduction for people who work for an employer.
I still find myself giving that explanation about TCJA to clients even in 2021, four years after tax law changes went into effect. Our clients refer to multiple articles they find online that explain the mechanics of home office deduction for W2 employees. Unfortunately, all of those articles are outdated and cannot be relied on. When searching the internet for tax answers, always make sure to check the date of information, as tax laws change often. In my personal experience, every president has left behind some kind of tax law revision. Obviously, another good source of information is the IRS itself, although their language might be difficult at times to understand.