Some taxpayers who have historically claimed the home office deduction might not be able to claim it based on the new tax laws in the Tax Cuts and Jobs Act (TCJA). This article is intended to provide guidance to taxpayers, including solo practitioners, who are interested in claiming the home office deduction after the TCJA took effect.
Changes to Standard and Itemized Deductions
A taxpayer can claim the standard deduction or itemized deductions to lower their taxable income. The standard deduction lowers a taxpayer’s income by a fixed amount while itemized deductions are made up of a list of eligible expenses. Taxpayers often select the deduction that lowers their tax bill the most and this decision can be made each year. The TCJA changed the standard deduction in 2018 by essentially doubling it and it simultaneously eliminated and modified some itemized deductions. These changes go into effect for 2018 tax returns that are filed in 2019 and are applicable from 2018 to 2025 unless Congress votes to keep some or all of the changes.
Tax Reform: Home Office Deduction Changes for 2018 Tax Year
Miscellaneous deductions for unreimbursed employee business expenses that were under itemized deductions have been eliminated under the TCJA. Eligible employees could deduct unreimbursed employee business expenses including the home office deduction as a miscellaneous deduction before 2018. Thus, employees cannot claim a home office deduction from 2018 to 2025 under the TCJA. Fortunately, taxpayers who are classified as an independent contractor, freelancer, or are self-employed are still eligible to deduct home office expenses against their self-employment income.
Internal Revenue Service’s Requirements for the Home Office Deduction
According to the IRS, if a taxpayer uses his or her home for business, he or she may be able to deduct expenses for the business use of his or her home. Furthermore, the home office deduction can be taken whether the taxpayer is a homeowner or a renter and the deduction is available for any type of home like a single-family home, an apartment, or a condominium.
Exclusive and Regular Use
In order to deduct expenses for the business use of a home, two elements must be present. Firstly, the business part of the home must be used exclusively and regularly for trade or business. Exclusive use means that the specific area is used only for trade or business purposes. The space should not contain personal items or furnishings, but the area does not need to be sectioned off by permanent partition. The most important part of exclusive use is that the area cannot be used for personal use at any given time. Regular use means that the area of the home is used on a continuous, ongoing, or recurring basis. Note that the IRS also states that this deduction is also applicable to freestanding structures such as a studio, garage, or barn if the taxpayer uses it exclusively and regularly for the business.
There are a couple of exceptions to the exclusivity element. The first exception is if the taxpayer uses part of the home for storage of inventory or product samples for the business on a regular basis. The second exception is if the taxpayer provides daycare services for children, people who are 65 years or older, or handicapped individuals in that part of the house. If this exception is claimed, the taxpayer must have a valid license, certification, or approval as a daycare center under state law according to the IRS.
If the requirements for the two exceptions are not met, then the taxpayer must still meet the exclusivity requirement.
Principal Place of Business
Secondly, the home office must be the taxpayer’s principal place of business which means that he or she uses the space exclusively and regularly for administrative or management activities. The IRS lists some activities that include billing customers, scheduling appointments, and keeping books and records.
If the home is used exclusively and regularly for the business and the home office is the principal place of business, then the taxpayer may claim the home office deduction.
Deductible Expenses: Regular v. Simplified Method
A taxpayer has two ways to determine the value of the deductions—the regular method and the simplified method. The regular method, also known as the actual expense method, requires taxpayers to determine the actual expenses, direct or indirect expenses, of their home office. These expenses include mortgage interest, insurance, utilities, repairs, and depreciation. Under this method, deductions for a home office are based on the percentage of the taxpayer’s home that is dedicated to business use. This method requires accurate record keeping that could be burdensome for some small business owners.
The IRS created the simplified method for taxable years starting on or after January 1, 2013. This method allows a qualified taxpayer to multiply a prescribed rate by the allowable square footage of the office in the midst of determining actual expenses. A taxpayer can claim a deduction of $5 per square foot for up to 300 square foot with a maximum deduction of $1,500. It should be noted that no home depreciation deduction or later recapture of depreciation for the years a taxpayer uses this method. The simplified method might make it easier for taxpayers to get the home office deduction, but it might not provide the biggest deduction.
The rules for the home office deduction may be difficult to understand, especially with the changes from the TCJA. Early tax planning helps taxpayers avoid unexpected and unwelcomed tax surprises. Thus, it would be beneficial to consult with a tax professional to understand the best option available for this tax year and the upcoming tax years that the TCJA apply. Whether a taxpayer qualifies for this deduction is determined each year. There is always a chance to be audited by the IRS regardless of how slim or great the chance. Therefore, a good rule of thumb is to keep good business records of income and expenses in the event of an audit.