A lot of small businesses don’t have an office or storefront, they work from their homes. For them, the IRS has created a special business tax deduction called the Office in Home Deduction. As part of a full disclosure, I do want to point out that a variation of this deduction is also available to employees who are required to work from home. If you think you might qualify after reading this post, please talk to your tax professional about the special guidelines and handling for employees. Also, for non-sole proprietors (partnerships and S-corps), check with your tax professional for specifics on how this needs to be handled.
The Office in Home (OIH) deduction allows the business owner to take a deduction against their business income for a percentage of the costs of operating their home. There are a few special requirements which have to be met. First, the office must be used exclusively for business. A spare bedroom that is not used for anything but the business meets the requirement. But if the bedroom is used by guests or when the grandkids sleep over, then the room doesn’t meet the exclusive test and there is no deduction. The key is to be a “special identifiable space.” So, a screened off end of the family room could qualify if the other requirements are met but not the den where you work on the business, pay personal bills and handle your investments. Next, the area must be the principle place of business for the business. Specifically, it is the place where the administrative and management functions take place. If you have an office at your shop and also have a set up to bring work home, that doesn’t qualify for OIH. But, if your shop doesn’t have an office space and all paperwork is done at home, the home space many qualify. The area must be used regularly. A dedicated business office still isn’t deductible if it’s only used occasionally. You also need to have a business that has a profit making objective. Hobby and investment activities do not qualify for OIH.
There are a couple of exceptions to these rules, after all this is taxes we’re talking about. The exclusivity test does not apply to in home day care facilities. A licensed day care can factor in the business hours the home is used into the calculations for the deduction. Also, storage areas for inventory or demonstration materials have a little looser exclusivity requirement. A few shelves in the garage or part of a closet will quality for OIH. Finally, if the home business area is a separate building from the home, it might qualify for an exception to the principle place of business test. A retail shop owner might keep season decorations and extra racks and shelves in a separate building at home and still qualify for OIH although no business takes place there.
The actual Office in Home for a business is calculated on Form 8829 and then carries to the Schedule C or F. The first issue is to determine the use percentage. This is the square footage of the qualifying “office” divided by the square footage of the whole building. This is further modified by hours actually used if the area is used for daycare or if usage began during the year. OIH expenses types are direct and indirect. Direct expenses are those which only apply to the area used by the business. The storage shed with a business’ inventory has a broken window; the repair cost is a direct cost. But most OIH expenses are indirect costs. These include mortgage interest, qualified mortgage insurance premiums and real estate taxes. The balance after the office in home deduction is subtracted can be used on the taxpayer’s Schedule A. Other OIH expenses are home insurance, rent, utilities, repairs and maintenance to the whole property and depreciation.
The catch? The Office in Home for a business can only be used to offset income from the business. Sort of. OIH expenses don’t come into play until all other business expenses are deducted from the business income. A tentative profit/loss is created and the OIH deduction can be taken into consideration. Form 8829 breaks the home expenses into three categories. The first are the mortgage interest, house taxes and mortgage insurance premiums. Since these are potentially deductible expenses on the Schedule A, they can create or increase a loss on the Schedule C or F. But other operating expenses (like insurance or rent) and the depreciation can’t cause or increase a loss. In that case, the unused expense deduction is carried forward to the next year. The other catch is if you own the home, the depreciation on the OIH area may have to be recaptured and taxed when the rest of the home meets the sale of personal residence exclusion.
If a small business qualifies, the Office in Home deduction can be a great benefit to the business owner. It allows him/her to deduct for the use of their home. But even better is the effect it has on commuting miles. Without the OIH, the miles to the first job or errand are commuting and not deductible. A valid OIH allows the business owner to log and deduct the miles they drive for business when they leave their home. Their commute is a very short walk.
Office in Home can be very confusing and as mentioned in this post, there several sets of rules for different situations. So, please check with your tax professional to see if you qualify for one of them.