Home Office Expenses and Tax Deductions for the Self Employed

Since many self-employed workers or freelancers conduct their trade or business out of their homes, the IRS allows for business tax deductions if they devote a part of their homes to business uses (I.R.C. Sec. 280A). That is, if they meet the following qualifications:

Exclusive and Regular Uses for Home Offices
As long as an area of a taxpayer’s primary residence is used exclusively and regularly for business (Sec. 280A(C)(1)), they can claim it as a deduction if the use is:


1. As the principal place of business (meaning if you already have a separate office for your business downtown, then you can’t claim your home office).
2. As a place of business used by patients, customers or clients dealing with the taxpayer (meaning if you meet clients or patients in the space, then you can claim it).
3. As a separate structure not attached to the house.

The exclusivity requirement is a strict one that can be stringently applied and there is very little tolerance. Even a minimal amount of non-business use can disqualify a space.

For example, Jane Smith set up a den in her home as a home office. Over the holidays and when guests were visiting, she folded out the couch in her office and used the room as a guest room. Even though the non-business uses of the den were limited, they were enough to disqualify Jane from taking a business deduction for its use.

However, it’s not necessary to devote a whole room to business use. As long as a specific area is designated and used exclusively for business, it counts. For example, a nook in the basement would qualify for a tax deduction provided that space was used exclusively and regularly for business purposes. But, if you’re claiming a separate structure like a detached garage or studio, the entire structure must be used for business purposes, not just a portion of it.

Exceptions to the Rule – Regular Uses That AREN’T Exclusive

A taxpayer who uses part of their home to provide care for children, seniors (people over the age of 65) or individuals incapable of caring for themselves is allowed to take a deduction for the part of their home used for that business, regardless of exclusivity (Sec 280A, Publication 587).

There is one other deduction allowed that does not require exclusive use – that is when a taxpayer uses part of their residence to store inventory or product samples in connection with their business selling products at the retail or wholesale level (eBay and online sellers, watch out, this one’s for you!)

The area used for storage doesn’t have to be used exclusively for storage, however the taxpayer’s residence must be “the sole fixed location of such trade or business” in order to qualify for the deduction (Sec 280A).

How to Calculate Your Home Office Tax Deductions
When calculating the deduction for a qualifying home office (or business use of a residence), the first step is to determine the percentage of the residence that qualifies for a deduction.

For example, Sally Smith runs a small online writing business out of her home office. Since her residence is her sole fixed business location and she uses the office exclusively for business purposes, she qualifies for an in-home office expense tax deduction.

If Sally’s home is 1,800 square feet and the room she uses as an office is 80 square feet (8 feet wide by 10 feet long), then she can claim that she used 4% of the total square footage of her home for business use.

When calculating for a free-standing structure, you can use either the square footage formula or the fair rental value (including outfitted equipment) of the separate structure.

Eligible Home Office Expenses
Once you’ve calculated the percentage of your home used for business purposes, the next step is to apply that percentage to eligible home expenses in order to claim those deductions.

Expenses that are eligible include:
1. Insurance
2. Property Taxes
3. Utilities
4. Repairs
5. Mortgage Interest
6. Security System Maintenance
7. Depreciation (calculated by taking the lesser of the home’s adjusted basis or fair market value, then deducting the land value, dividing the remainder by 39 and applying the percentage to this figure).

If you’re renting your residence, you may apply your percentage to your rent and the utilities that you are responsible for as a tenant.

A Final Word on the Potential Drawbacks of Taking a Deduction for the Business Use of a Residence
While taking a tax deduction for your home office may seem like a good idea, there is a down side, particularly if you want to avoid paying capital gains tax when selling your home. According to IRC Sec 121, if a taxpayer has owned a residence for two or more years and has occupied it for at least two of the last five years, they’re eligible to exclude up to $500,000 of any capital gains from taxation. However, any amount included in a prior depreciation deduction is not included in a capital gains exclusion.

For example, if you claimed $4000 in depreciation on the percentage of your home that you use for your business and then sold your home for a gain of $40,000, you’d only be able to exclude $36,000 while the other $4000 would remain eligible for taxation.

So, if you’re planning on selling your home, you may want to reconsider claiming depreciation as an in-home office expense tax deduction.