If you're a business owner working from a home office, you may be leaving money on the table. Here's a rundown of the tax deductions available to you.
I have been blogging for nine years and working from home that entire period. However, I've only written about the tax breaks available to those with a home business a single time, and it was about how I'm not getting any of them! Well, things have changed over the years and it's time to hit this topic again.
The Home Office Deduction
The first tax break to consider if you work from home is the home office deduction. This used to be a really complicated deduction to take. You had to figure out all the costs of your home (mortgage, property taxes, depreciation, utilities, etc.) and then multiply them by the fraction of your home used by the business.
However, beginning in 2013, the IRS offered a MUCH easier way to take this deduction. You simply calculate out the square footage of the home office and you take $5 per square foot as a deduction. It goes on line 30 of Schedule C for a sole proprietor, line 20 of Form 1065 for partnerships, and line 19 of Form 1120S for S Corps. (Technically for an S Corp you should set up an “accountable plan” where the business reimburses you those expenses and then places them on line 19. We do this for lots of WCI expenses these days.)
You can still use the old method (and you have to if your home office is greater than 300 square feet), but I'd try to avoid it just for simplicity's sake. Unfortunately, that $5/square foot figure is not indexed to inflation. Also, unless you're in a pretty inexpensive home (especially if renting) going through the 44 line Form 8829 is probably going to get you a larger deduction than the simplified method. But AT LEAST take the simplified method. The simplified method also has the advantage of not being recaptured when you sell the home, which is worth something.
3 Rules to Qualify for the Home Office Deduction
#1 Must be the Principle Place for Your Business
This one can get tricky, although it's easy for many for whom there is no other place they do business. If there is another place you do business, the IRS considers
- the relative importance of the activities performed at each place where you conduct business, and
- the amount of time spent at each place where you conduct business
in making the determination.
#2 Must be Regularly Used
This one usually doesn't trip too many people up, but if you aren't working at home each week you might not meet this requirement.
#3 Must be for the Exclusive Use of Your Business
This one trips people up far more often. Exclusive use means that the square footage you're claiming for a home office isn’t used for anything else. It can't double as a guest room, a non-business storage space, a place for the kids to do their homework, etc. The idea is that just because you run your business off your dining room table, you can't deduct your dining room as a home office.
The last few years we claimed the home office deduction for the basement bedroom where we record White Coat investor podcasts and videos. When we did our renovation, we dedicated a significant amount of space to WCI office space (in fact it might be a little more than 300 square feet) so we'll surely be taking this deduction going forward. But despite the fact that I do hours and hours of work in the kitchen, living room, and dining room, we don't claim that space as a home office due to the “exclusive use” requirement.
Can Employees Deduct a Home Office?
So what if you're an employee and not a business owner? Can you deduct a home office? Unfortunately, starting in 2018 the place where this unreimbursed employee expense deduction was taken on Schedule A (itemized deductions) is basically gone. Plus, fewer people are filing Schedule A due to the higher standard deduction. It was never that great for doctors anyway since it was subject to a floor of 2% of Adjusted Gross Income, a substantial figure for most docs.
Deducting Business Mileage
If you're working at home AND somewhere else, driving between those two locations becomes deductible business mileage rather than non-deductible commuting mileage. I don't even think there is a rule that you must take a qualifying home office deduction in order to take the business mileage deduction, but it certainly makes it look less squirrelly.
This deduction is because you are driving between two places of business (the home office and the other place of business) rather than home and the business (commuting). Keep in mind that there is a requirement that the two places of business must be in the same industry. So just because I blog at home before going into a shift at the hospital doesn't mean I can deduct that mileage. Different industries, so it's not business mileage, it's a commute.
Lots of doctors get into a gray area with this. They reason that since they check their email or do some charts at home they can then deduct their drive to the clinic or hospital. Keep careful records and realize this may or may not hold up in an audit. The key is really to avoid having some other place that is the principal place of business. If you're a hospitalist working shifts at 4 different hospitals, that is going to be a lot easier to argue than if you are an internist who always works in the same clinic.
Renting Your Home to Your Business
You know what the best possible deduction is for a home-based business? Renting your home to your business. This is a deductible expense to your business. And if you do it less than 15 days a year, it is not taxable income to you as an individual. Did you get that? This is FREE MONEY. And it can be a lot of money.
For example, I have business meetings at my home. The space we claim as a home office is too small for those meetings, so we basically have to use the area where my family lives like the dining room. Rather than just giving this space to the business, why shouldn't I charge the business rent? It is certainly allowed.
So what is the going rate? Well, that's pretty easy to figure out these days with VRBO or AirBNB. And since I live in a big fancy doctor home very close to some very popular ski resorts, the going rate to rent out my home for a business meeting is actually pretty high. Especially when you tack on a cleaning fee, a booking fee, and taxes. Go ahead, see what a single night in your own house would cost you to rent. You'll probably be surprised at how expensive it might be, especially during prime tourist season. This deduction is an order of magnitude larger than what I can take for the home business deduction. But it isn't “either/or”. It's “both”.
Do I have 14 business meetings a year at my house? Absolutely. The minutes for these meetings are well-documented. They last for hours. If I wanted to rent out a hotel suite, conference room, or private house for these meetings the cost would be substantial. That cost is now a deduction. Would it be a smart business move for my company to rent out a private fancy doctor house to have their meetings? Maybe not, but the IRS does not require you to make smart business moves in order for your expenses to be deductible.
deducting more renting your own home for more than 14 days though. All you're doing then is shifting income from the business return to your individual return. If the business is a pass-thru entity like a sole proprietorship, partnership, or S Corps, you're probably not saving any money there.
Where does this expense go? I'd put it on Part V of Schedule C (lines 48 and 27a) or lines 20 or 19 of Form 1065 or 1120S respectively.
Of course, don't forget all those office supplies, office furniture, second phone line, computers, etc. If you use it more than 51% of the time for the business, it's a business expense, although you can only deduct the % of the expense that is actually used for business. That is, if you use a $500 chair 60% of the time for business, it's a $300 deduction, not a $500 deduction. You better believe all the furniture going into the new WCI office space is going on the WCI credit card.
What do you think? Do you take the home office deduction? Why or why not? Ever rented your home to your business? Why not? Comment below!