Understanding the Home Office Tax Deduction

The COVID-19 pandemic forced millions of employers and their staff to adjust to impromptu remote work and home office situations. With this change, many are seeing an increase of costs related to internet, power, and other utilities. As tax season is now in full swing, we are fielding questions from organizations and individuals wondering whether remote work situations qualify for the home office Federal tax deduction. In the following, we break down the basics for you.

Home office deduction for the self-employed

If you are an independent contractor, a sole proprietor, or self-employed, and you use a portion of your home exclusively and regularly for business, you could be entitled to home office deductions. There are several expenses that potentially fall under this umbrella, including electricity, water, gas, trash collection, maintenance, depreciation, repair, internet, insurance, rent, real estate taxes, mortgage interest, and the costs of installing and maintaining home security systems.

Beyond utilities, if you have made improvements to your home to accommodate your work situation, you may be able to deduct these expenses as well. Purchases like furniture, computers and accessories, and general office supplies may qualify.

Listed properties, or items used for both business and personal, must be utilized more than 50% annually for depreciation to be claimed on the business-use portion or be deducted as an applicable expense. These include your phone system, some furniture and computers, and peripheral equipment like wireless routers, desktop cameras, and printers. If the listed property is not used more than 50% for business, then you can only use the slower “straight line” depreciation method, and you cannot deduct it under the expensing provisions. However, if they were placed in service after 2017, they may be eligible for regular depreciation, or they can be deducted in full without having to meet the 50% business use test.

If you want to claim your deductions, you have to use part of your home for one of the following:

• Regularly and exclusively as a primary place of business for a trade or a business.
• Regularly and exclusively as a place where you meet with clients, patients, or customers in the normal course of a trade or business.
• As a separate structure not attached to the home, used regularly and exclusively in connection with a trade or business.
• Regularly for storage, inventory, or product samples that are used in a trade or business of selling products at retail or wholesale.
• For rental use.
• As a daycare facility.

Once the “regularly” and “exclusively” tests have been satisfied, the home office deduction is calculated by dividing the area of the office portion over the total area of the house to calculate the percentage of expenses that can be claimed, and then prorating for use over the year. This can be complicated in certain circumstances so it is highly recommended you coordinate with your tax advisor before claiming this deduction.

Home office deductions for partnerships

If you are a partner of a partnership and use a portion of your home regularly and exclusively for partnership business, you can deduct the home office expenses as long as the expenses will be paid without reimbursement under the partnership agreement or the firm policy. If the expenses include losses from a passive activity, be sure to enter them as well. It requires several forms to properly calculate acceptable reimbursable expenses.

As the shareholder of a corporation

If you use a part of your home regularly and exclusively for a corporation’s business as a shareholder of a corporation (either a regular “C” or subchapter “S” corporation), you are essentially an employee of the corporation, and unfortunately, no home office expense deductions can be implemented.

Home office deductions for W-2 employees

Prior to the Tax Cuts and Jobs Act (TCJA), a W-2 employee was able to claim itemized deductions for unreimbursed employee business expenses, including those home office expenses, as miscellaneous itemized deductions. The TCJA temporarily eliminated most miscellaneous itemized deductions at the federal level.

Through 2018-2025, you can’t deduct home office expenses at a federal level as an employee. But don’t despair. They may be currently deductible as itemized deductions in some states, including New York. Therefore, under current law, your home office expenses aren’t deductible on your Federal tax return. After 2025, however, those expenses may be claimed as miscellaneous itemized deductions at both the federal and state levels—but will be subject to rigorous rules.

Final thoughts

The Home Office Deduction can be a powerful way to limit your federal tax burden. However, historically, the Home Office Deduction has earned a reputation as an IRS audit trigger. The likely major increase in claimants for 2020 taxes, and the fact that most employees will not be able to take the deduction, means those that do claim it could be at high risk for IRS scrutiny. We recommend that you consult with dedicated tax professionals before claiming the Home Office deduction on your 2020 tax returns.