Many people defer taking the home office deduction tax write-off because they are scared it will trigger an IRS audit. Put simply, the home office deduction audit is a myth.
In this article, we'll go over how this is a common misconception for people who work from home. This article will review what the home office deduction audit really means and how you can take advantage of this tax benefit without any fears.
Let's first dive into why the myth exists among taxpayers in the first place.
Why Do People Think Taking The Home Office Deduction Will Trigger An Audit From The IRS?
The IRS has allowed self-employed workers to deduct a portion of their home office from their taxes for quite some time. The tax break has gotten a bad reputation over the years by taxpayers to be an automatic red flag for investigation by the Government.
Many self-employed workers are scared of the requirements for record-keeping in order to claim the home office deduction.
Although some individuals who take this deduction may be audited, you really have nothing to worry about if you qualify for the tax deduction and keep clean records.
The myth really started because of a tax code change. The Tax Reform Act of 1976 added Section 280A which allowed business owners to deduct expenses like utilities, home insurance, home repairs, and depreciation on home. The home office tax deduction was simply misused in the past, which made it known for IRS scrutiny.
Folks who thought they qualified for the deduction, had to pay the write-off amount back from the prior year.
If you are able to qualify for the tax deduction, that doesn't mean you'll be audited every year. The IRS has a lot of audits going on as it is without adding this one to their list so they don't target home office deductions specifically in order to expand their audit pool.
Let's discuss when the Internal Revenue Service identifies sketchy tax returns.
The Automatic IRS Examination Process
The fact that a return has been selected for review does not always imply that the taxpayer has made an error or has been dishonest.
Some investigations even result in the taxpayer receiving a refund or the return being accepted as is.
The Internal Revenue Service uses a system called the Discriminant Information Function (DIF) to flag tax returns that appear to have significant deviations from the averages of others in your profession. I'll show you what I mean.
If the average tax deduction for someone in your line of work deducts 10% of their income for business meals and you write-off 35%...the discrepancy from the average could trigger a closer examination by the IRS. This really goes for all the 1099 deductions, really.
When it comes to the home office tax deduction, this just means you have to file for a reasonable deduction and everything is properly recorded or you track all 1099 expenses.
Requirements To Qualify For The Home Office Deduction
First off, you must be a self-employed worker or independent contractor to file for this tax deduction. Employees cannot qualify for this deduction.
As a self-employed worker or partner, you may be able to deduct some expenses for the part of your home that you use for business if you meet the following qualifications.
Principal Place of Business Requirement
There are many rules that apply to this deduction. The rules are fairly straightforward. To write-off expenses for business related use of the home, you must use part of your home as one of the following:
- Exclusively and regularly as your principal place of business for your trade or business;
- You must use it exclusively and regularly as a place where you meet and deal with your patients, clients, or customers in the normal course of your trade or business;
- A separate structure that's not attached to your home is used regularly and exclusively in connection with your trade or business
It is important that your office is regularly for business and the area or space is exclusive. If you are an employee and you pick up gig work on the side, you can still qualify for the deduction. You must meet the requirements of a self-employed person and not just an employee.
Other Eligible Uses
Here are some other IRS-approved ways you can write off a home office.
- If you use a space on a regular or exclusive basis for the storage of inventory or product samples used in your trade or business of selling products at retail or wholesale;
- For rental use;
- As a daycare facility
The IRS' Definition Of What Counts As A Home
According to the IRS, the rules for what qualifies as a "home" is:
- a house, apartment, condominium, mobile home, boat or similar property
- structures on the property, like an unattached garage, studio, barn or greenhouse
This does NOT include any part of the taxpayer's property used exclusively as a hotel, motel, inn, or similar business.
What Auditors Will Look For
If your deduction is examined, auditors will check to see if your small business meets all the criteria of the law. Your office space must be your principal place of business. The government will also check to see how important the tasks or activities were for your business and where they were performed.
Be careful of including decorations or anything that would indicate you are doing something personal in the office space. Decorations that may be flagged for using your office for personal use could be a dartboard, stereo, or anything else that may seem like a personal item. The safest precaution you can take is moving any personal items out of your office area to somewhere else.
You cannot claim the deduction if you use your bedroom or family room to conduct your business. These areas aren't viewed as regular business use or primary place of business.
The Methods Available To Claim The Home Office Deduction
If you qualify for the home office deduction, the IRS provides two ways you can claim the write-off: the regular method and the simplified method.
Let's break down each of them.
Regular Method
In order to use this method, you'll need to fill out and attach Form 8829 to your tax return. This form is for expenses and business usage of your home.
In order to calculate the deduction amount using this method, you'll need to sum up all of your actual expenses related to maintaining or operating your workstation. You can track your expenses with our home office deduction spreadsheet.
These home office actual expenses include:
- Insurance
- Reparations
- Depreciation
- Utilities
- Mortgage Interest
- Cleaning costs
Then, you'll need to multiply the total by the "business use" percentage or how often you use the space for business and personal use. So, keep track of how much time you spend in the section of your house for business. You could also use a 1099 expense tracker to help you record these expenses.
For example, if you use a whole room or section of a room for conducting your business, you'll need to figure out the percentage of time you use it for your business activities.
It should be noted that if you move houses or home office spaces, you'll need to fill out a separate Form 8829.
The Simplified Method
After January 15, 2013, the IRS introduced the home office Simplified Method to write-off a home office space where you conduct business. All you need to do is measure the space of your home office and multiply it by the sure footage rate provided by the Internal Revenue Service.
Currently, the rate is $5 per square footage of home used for business (maximum 300 square feet or $1,500). Remember, you can only deduct the square feet for regular and exclusive use as a home office.
You can only use this method if no other deductions like home repairs, mortgage interest, or utilities are taken. If you sold your home after taking the home office deduction, there is a depreciation recapture provision which could mean paying higher taxes. The recapture rule can surprise many small business owners who take the home office deduction.
Picking The Right Method
Which method can lead to a higher deduction for you? I believe that the actual expenses method generally helps businesses get a higher deduction. Sure, although it may require more documentation and is not as easy as the Simplified Method, you can save a lot of money on your taxes by claiming the Actual or Regular Method. Due to the coronavirus pandemic, many employees forced to work from home can claim a home office reimbursement.
You should still calculate the total write-off amount of both methods to decide which one is better for you.
If you have questions about how to write-off for an office room from your taxes, contact a legal or tax professional.
