Home Office Deduction: How to Know if You Qualify + Calculation

The home office deduction is one of the many tax breaks that self-employed taxpayers can use to reduce the taxes they owe. It entails itemizing all business-related expenses incurred for the year on their tax return and deducting the total expenses from their taxes.

The IRS has specific conditions and requirements when it comes to using the home office deduction, and it depends on the type of expense or cost declared by the taxpayer.

In this article, we’ll explore this tax break in more detail and see who qualifies for it.

Let’s begin!

Key Takeaways

• The home office deduction is a tax deduction for self-employed individuals—freelancers or sole proprietors—who use part of their home to operate their business.
• The home office deduction for W-2 employees is no longer in effect after the Tax Cuts and Jobs Act (TCJA) suspended reimbursement of employee expenses until 2025.
• You can calculate your home office deduction using the simplified method or the actual expenses method.
• To qualify for a home deduction, you must pass the IRS’ regular and exclusive use test. Your business and home office must also meet certain requirements to qualify as a business.

How Does the Home Office Deduction Work?

The home office deduction entails enumerating all housing expenses used for business or work purposes, such as rent, mortgage, repairingand renovating a room into a home office, depreciation, utilities, maintenance, and insurance.

Self-employed individuals and sole proprietors who own a house, a condominium, a mobile home, or rent an apartment can claim the said deduction, provided that they exclusively use their residential space or a portion of it for their business.

Detached structures of the house, such as a garage, greenhouse, or barn, used to conduct business activities are also acceptable when claiming a home office deduction. The deduction does not work for hotels, youth hostels, motels, or other short-term lodging.

That said, the IRS has four ways to accurately gauge the eligibility of self-employed taxpayers claiming deductions on their home expenses, namely:

• Regular use test
• Exclusive use test
• Principal place of business
• Nature of the business

Regular and Exclusive Use

In terms of how you use your residential space for your business, the IRS requires that the dedicated workspace in your house be for regular and exclusive use. This is also known as the ‘regular use’ and ‘exclusive use’ test.

Under the exclusive use test, your home office must be dedicated regularly and exclusively to conducting your business. The regular use test entails using your home or part of it for your business recurrently, continuously, or on an ongoing basis.

You cannot use your home office for non-work related purposes, such as taking personal phone calls or pursuing your hobbies.

At the same time, if you do not have a dedicated space, room, or structure at home where you can conduct your business, then you may not claim the home office deduction on your returns.

The exceptions to the regular and exclusive use test only apply to the following self-employed individuals:

• Retailers and wholesalers who use their basements to store samples and product inventories in their homes for business purposes.

• Self-employed providing in-home daycare for children, people aged 65 and older, and persons with disabilities who cannot take care of themselves on their own.

• Individuals offering in-home daycare services who have the necessary certification or license and the proper authorization from the state where they reside.

Principal Place of Business

Aside from using your home office or designated work space exclusively and regularly for business, your residential space or home office must also be the main location where you hold meetings with business partners and clients or accommodate customers.

You may still qualify for a home office deduction if you conduct your business somewhere other than your home office, as long as you carry out management-related and administrative duties in it.

What Qualifies as a Business?

Firstly, your operations must generate a steady income or profit to qualify as a business. Take time to assess the amount of effort and time you need to exert to make money out of your business and ensure its continuous operation.

If your business does not make you any profit, then the IRS may consider your business a hobby. You cannot claim a tax deduction on expenses and losses incurred from pursuing leisurely activities.

You must also consider whether your business enables you to generate a continuous and stable income that lets you afford your essential and regular expenditures.

How to Calculate Your Home Office Deduction: 2 Main Methods

There are two methods you can use to calculate your home office deduction: the simplified method and the actual expenses method.

#1. Simplified Method

The simplified method involves subtracting $5 for every square foot of your home office or the space in your residential property that you dedicate solely for business use. You can subtract up to $1,500 from the taxes you owe or use up to 300 square feet of your home office.

When using the simplified method, you must fill out the Simplified Method Worksheet.

Say your home office takes up 275 square feet of your house. All you have to do is multiply 275 square feet by $5 to determine the total home office deduction you can claim on your tax return.

Given how easy it is to calculate your home office deduction using the simplified method, it is often the go-to method for most self-employed individuals and small business owners.

However, it may not be a suitable choice if you need to itemize several home office expenses and only use a small portion of your residence as your home office.

For instance, let’s say you are renting an apartment, and your home office takes up 100 square feet of your residential space. At the same time, your combined rent and utility expenses are worth $1,200 per month (or $14,400 per year).

The simplified method will only allow you to deduct up to $500 from your taxes, an amount that clearly underestimates the actual expenses that you have to shell out regularly to keep your operations afloat.

#2. Actual Expenses Method

Also called the regular method, the actual expenses method is a more detailed process because it requires you to add all your direct self-employed expenses and deduct the sum total from your taxes.

Direct expenses refer to the repair and maintenance done to your home office alone. As such, if you incurred a total of $6,800 in repairs to your home office, then you can deduct the said amount from your taxes in full.

Alternatively, you may add your indirect expenses and use the percentage of your residence used for work or business to determine your deductible home office expenses. Indirect expenses include mortgage interest, real estate taxes, and utility costs such as your internet and electricity.

Now, let’s say you accumulated $7,500 in indirect expenses, and your home office comprises 300 square feet of your 2,000 square foot home, or 15% of your residential space. You can then claim 15% of your expenses—or, in this example, $1,125 for your home office costs.

Do You Qualify for a Home Office Deduction if You Work From Home?

You do not qualify for a home office deduction if you’re an employee working from home.

Before the Tax Cuts and Jobs Act (TCJA) was passed into law, employees working from home who also received a Form W-2 were allowed to claim their unreimbursed employee expenses.

Presently, the said tax break remains suspended for work-from-home or remote W-2 employees until 2025. Meanwhile, the home office deduction for the 2023–2024 tax year remains exclusive to independent contractors, sole proprietors, and startup owners.

Conversely, the home office deduction for remote workers may be allowed, provided that the W-2 employee also has an independent contractor job or a business as their sideline that they operate in their residence.

3 Crucial Details to Consider When Estimating Home Office Deductions

Estimating your home office deductions requires careful scrutiny of your actual business costs—both direct and indirect—and your average net profit. It also demands full transparency on your part to ensure there are no discrepancies on your tax returns.

You should also take note of the following details and use them as your guide when reporting your self-employed income and calculating your possible tax deductions later on:

#1. Depreciation

Depreciating your house’s value is required if you use the actual expenses method to calculate your home office deduction.

The Internal Revenue Service allows homeowners to get a refund for the housing costs brought on by the deterioration, wear, and tear, and antiquation of their residential property by deducting the expenses from their income taxes.

When you include your home’s depreciation in your home office tax deduction, you may be subject to paying capital gains tax when you sell your property.

#2. Home Office Deduction Forms

Aside from carefully enumerating and determining your home office deductions, you must also know the correct tax forms to use when filing your taxes. The following IRS forms are essential to claiming your home office deduction:

• Form 8829, Expenses for Business Use of Your Home. Use this form to itemize and assess all allowable home office costs that you can claim or deduct from your taxes.

• Schedule C (Form 1040). Schedule C reports business income losses for sole proprietors. All information reported on your Form 8829 is reflected on Line 30 of your Schedule C.

• IRS Publication 587, Business Use of Your Home. While technically an IRS publication and not a type of tax form, Publication 587 provides you with an in-depth guide to evaluating the home office deductions you can claim.

#3. Receipts and Financial Records

Make it a habit to collect and record receipts from clients and billing statements from suppliers and utility service providers.

If you are a freelancer, prepare an independent contractor pay stub each time you receive payment from your clients so you can subtract your home office expenses from your average gross income.

Similarly, if you own a startup, use Paystub.org’s invoice generator and create professional invoices for every client order or purchase. Our generator comes with ready-made templates that you can easily fill in with all the essential details in minutes.

Having complete records of your business transactions helps prove that you have a legitimate business, increases your chances of qualifying for more tax deductions, and justifies your reported business expenses in case you get selected for a tax audit.

Final Thoughts

Managing a business and earning money independently as a freelancer can be quite challenging, with all the costs and tax obligations that you have to fulfill.

Fortunately, the home office deduction is one of the many types of tax deductions for independent contractors that you can maximize, particularly if you want to manage your tax liabilities and regulate your business expenses more seamlessly.

When calculating your home office deductions, keep in mind that it is important to know your limitations and qualifications and adhere to existing IRS regulations to maximize this specific tax break.