‘Tax Explainer: How Home Office Deductions Work’
Understanding the home-office deduction rules will help avoid IRS headaches in the future.
3 min read

Education

23 December 2023

Tax Explainer: How Home Office Deductions Work

Angie M Grainger

The home office deduction allows self-employed individuals and some employees who work from home to deduct certain expenses associated with the use of a part of their home for business purposes.

Qualifying for the Home Office Deduction

  • Exclusive and Regular Use: The part of the home claimed for the deduction must be used regularly and exclusively for conducting business. It could be a separate room or a defined area used solely for business activities. The space cannot be used for any personal activities.


  • Principal Place of Business: For self-employed individuals, the home office must be the primary location where they conduct substantial activities of their trade or business.

Expenses Eligible for Deduction

  • Direct Expenses: Expenses directly related to the home office space, such as repairs and maintenance specific to that area, could be deductible. These might include painting the home office or repairs specific to that space.


  • Indirect Expenses: Part of certain indirect expenses, such as mortgage interest, property taxes, utilities, homeowners insurance, and home maintenance, can be apportioned and deducted based on the percentage of the home used for business.

Limitations

  • Cannot Create a Loss: A home office deduction cannot take your profits below zero. Instead, any excess will be carried forward to deduct against future income.


  • Home Renovations and Improvements are Generally Not Fully Deductible: The costs of home renovations or improvements, such as adding a home office or remodeling for business purposes, are typically not fully deductible in the year they're incurred. Instead, they may be capitalized and depreciated over time, potentially contributing to the basis of the home.

    • Depreciation: If a renovation directly benefits the home office space, a portion of the cost might be depreciable as part of the home office deduction

    • Depreciation and Its Impact on the Sale of Your Home: If you've taken depreciation for a home office use of your home, this reduces your cost basis in the property. When you sell your home for a profit, the portion of the gain attributable to the depreciation may be subject to recapture.

    • Recapture:The recaptured depreciation is taxed as ordinary income, not at the lower capital gains tax rate. This means it can result in a higher tax liability.

Maintaining detailed records is crucial to substantiate the home office expenses claimed. This includes records of home-related expenses, receipts for renovations or improvements, and documentation proving the business use of the home office space.

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