What is the home office deduction?

The exclusive use and regular use tests

The exclusive use test means the space is used only for business, and the regular use test means you use it for business on a regular basis, not now and then. The space can be a room or another separately identifiable space, and it doesn't need a permanent partition.

A den you work in that your family also uses for recreation fails the exclusive use test. Keep personal furniture and activity out of the space, and take a dated photo of it.

The principal place of business test

Your home office passes the principal place of business test if you use it exclusively and regularly for administrative or management work and you have no other fixed location where you do substantial administrative or management work. The IRS counts billing, keeping books and records, ordering supplies, setting up appointments, and writing reports as administrative work.

Three things don't disqualify you: doing your main work at client sites, doing some paperwork from a car or hotel room, and having suitable office space elsewhere that you choose not to use. IRS Publication 587 gives the example of a plumber who works at customers' homes and an anesthesiologist who does their paperwork at home instead of at the hospital office.

A home office can also qualify as a place where you physically meet clients in the normal course of business, or as a separate structure you use exclusively and regularly for the business.

Exceptions for inventory storage and daycare

There are two uses which don't have to meet the exclusive use test: storing inventory or product samples, and running a daycare.³

Storage qualifies only when all five conditions apply: you sell products at wholesale or retail, you keep the inventory at home for the business, your home is the only fixed location of the business, you use the space regularly, and the space is separately identifiable and suitable for storage.

A daycare figures its business share by time as well as space, using the daycare worksheet in IRS Publication 587.

Can you take the home office deduction as a W-2 employee?

No, you can't take the federal home office deduction as a W-2 employee, because miscellaneous itemized deductions for employee business expenses were eliminated for tax years beginning after 2017.

If you also have self-employment income from a side business, the home office you use for that business can qualify on its Schedule C.

Step 1: Measure your office and your home

Measure the length and width of the space you use only for business, then the total finished area of your home. In the example, a 10 by 20 foot office is 200 square feet, and the apartment is 1,600 square feet.

Step 2: Figure your business-use percentage

Divide your office's square footage by your home's total square footage to get your business-use percentage. In the example, 200 ÷ 1,600 = 12.5%.

If your rooms are about the same size, you can divide the rooms you use for business by the total number of rooms instead. This percentage is for the regular method only, because the simplified method uses square feet directly.

Step 3: Figure the simplified method amount

Multiply your office's square footage, up to 300, by $5 to get the simplified method amount. In the example, 200 × $5 = $1,000.

Then apply the limit: the amount can't exceed your gross income from the business use of the home minus your business expenses unrelated to the home. You'll use the Simplified Method Worksheet in the Instructions for Schedule C to do it.

Step 4: Figure the regular method amount on Form 8829

Figure the regular method amount on Form 8829, which has four parts: business-use percentage, allowable deduction, depreciation, and carryover to next year. In the example, rent of $24,000 a year plus $2,400 of utilities and renter's insurance is $26,400, and 12.5% of it is $3,300 before the limit.

Part I takes the percentage from Step 2. Part II applies the limit in order: expenses you could deduct anyway come first (mortgage interest and real estate taxes), then operating expenses, and depreciation last.

Part III of Form 8829 is where you depreciate the business part of a home you own, over 39 years. Part IV carries any unused amount to next year. Use a separate Form 8829 for each home you used for business during the year.

Step 5: Choose a method and enter it on Schedule C, line 30

Choose the method that gives you the larger allowed deduction this year, then enter it on Schedule C, line 30, from line 36 of Form 8829 or from the Simplified Method Worksheet.⁴ In the example, that is $3,300 under the regular method vs $1,000 under the simplified method, if the business profit covers both.

You make the choice on a timely filed original return, and you can't change it for that year. Next year you can choose again. The Schedule C instructions guide covers the rest of the form.

If your business has a loss or a small profit

If your business has a loss or a small profit, the deduction limit can cut your home office deduction to zero for the year. The limit is your gross income from the business use of your home minus business expenses unrelated to the home, such as advertising, supplies, and equipment depreciation. Half of your self-employment tax is not subtracted.

Under the regular method, the amount you can't deduct carries over to the next year you use the regular method, even if you move. Under the simplified method it is lost, and a carryover from an earlier regular-method year can't be used in a simplified year, so it waits for the next regular-method year.

In a loss year, run the regular method on Form 8829 so the unused amount carries forward.

If you rent your home

If you rent your home, you can deduct your business-use percentage of the rent you pay under the regular method. A homeowner can't deduct a fair rental value for their own home and depreciates the business part instead.

If you used your home office for part of the year

If you used your home office for part of the year, you can only count expenses or space for the months you used it. Under the regular method, you count only expenses from the months of business use, so an office first used on July 1 counts expenses from July through December.

Under the simplified method, add the allowable square feet for each month, up to 300 a month, and divide by 12. A month with fewer than 15 days of business use counts as zero.

If you sell a home you depreciated

If you sell a home you depreciated for a home office, you can't exclude the part of the gain equal to the depreciation you deducted, or could have deducted, after May 6, 1997. Years under the simplified method carry no depreciation and no recapture.

Keep each year's Form 8829, because depreciation you were entitled to still reduces your exclusion if you skipped it. IRS Publication 523 covers the rest of the rules for selling a home.