Many of us have rearranged, redecorated, or reimagined our homes to convert them into office spaces this year. This new swell of people working remotely has sparked questions regarding home office expenses and whether they qualify for a deduction.
The answer is: it depends. If you are a W-2 employee, unfortunately, the answer is no… for your federal return. California, along with six other states—New York, Pennsylvania, Hawaii, Minnesota, Arkansas, and Alabama—passed its own reimbursement laws, which may allow you to deduct certain unreimbursed home office expenses under the new remote working environment.
California has been at the forefront of the employee reimbursement debate, requiring employers to reimburse workers for reasonable and “necessary expenditures or losses incurred by the employee.” Examples include cell phone usage, personal printer, and office supplies, among others. This means that if you have unreimbursed employee expenses, they are still deductible on your state tax return. Even if you take the standard deduction on your federal tax return, California will allow you to claim itemized deductions on your state return.
Under the Tax Cuts and Jobs Act (TCJA) of 2018, however, new provisions effective 01/01/2018 eliminated long-standing federal rules related to unreimbursed work-related expenses. Pre-TCJA, employees could deduct qualifying expenses in excess of 2% of adjusted gross income. They could also claim deductions for their home offices if they worked remotely for an employer. The CARES Act does not amend this rule, nor does it make a temporary provision allowing a home office deduction in the time of COVID.
The good news is that if you’re self-employed or own a small business, you will likely be eligible to claim a home office deduction on your federal return if you’ve been required to work from home during COVID. To determine if you qualify, reference this IRS flow chart to answer a set of simple questions, such as whether your home is used “exclusively and regularly” as your primary place of business and if you meet clients or patients in your home.
The only other business group that may qualify for the home office deduction are partners who formerly worked out of a collaborative workspace and decided to transition out of the physical location into a home office. Claiming a home office deduction under a partner status is still a gray area, so you’ll want to ensure that your home can be clearly defined as a regular and principal place of doing business. For example, designers, architects, or therapists could potentially transition seamlessly from an office environment to working from home, but a partner with a headquarters in New York may not.
In order to calculate the allowable deduction amount, the IRS provides two methodologies, the simplified method or the regular method. You can look into which method may be most appropriate to your situation and home type. In short, the simplified option is based on $5 a square foot, for up to 300 square feet, and capped at $1,500 per year. You can also claim mortgage interest and real estate taxes on Schedule A, but unfortunately, you are unable to deduct any depreciation expenses during the years you use the simplified method. The IRS developed this option for small businesses in an effort to reduce lengthy paperwork and recordkeeping.
For businesses with much larger, more complicated spaces, the regular calculation may yield better results. This calculation can be determined by dividing the area used for your business by the total area of your home or by dividing the number of rooms used for your business by the total number of rooms in the home (assuming room size is similar). For example, if you designate 1 room out of 10 rooms for your office space to exclusively conduct business, then you will want to deduct 10% of all qualifying business expenses from your tax return. Your calculations will need to be reported on IRS Form 8829 and attached to your business return.
So, what qualifying business expenses should you consider applying the example 10% deduction? Here’s a list of expenses that may be eligible.
- Mortgage interest and property taxes (or rent if you do not own the home)
- Utilities (electric, gas, trash, water, and sewer)
- Insurance costs (homeowner’s insurance or business insurance)
- Home maintenance costs on the office space
- Depreciation on portion of home qualifying as home office
With unemployment rates as high as 14% in California (some states have as high as 17%), it’s likely that more people will form new small businesses or become self-employed this year, as many job opportunities have been reduced due to business closures. Be sure to look into the various tax planning strategies available to small business owners and to deduct the appropriate amount from your tax returns so you’re not overpaying in taxes.
If you have any questions regarding home office expense deductions or unreimbursed work-related expenses, please contact me at firstname.lastname@example.org or (805) 963-7811.