How to Calculate a Home Office Deduction Correctly
For those of you who’re just joining in, part one mentioned my responses to a query from Abigail, a self-employed consultant who uses part of her home to conduct her business.
Part two focused on three requirements Abigail must satisfy to qualify for home-office deductions. First, she uses a dedicated space in her home exclusively for work in her business. Second, she does so on a regular basis. Third, it’s her principal place of business.
Part three explains how she calculates her deduction on Form 1040’s Schedule C (Profit or Loss From Business). The IRS authorizes two ways for her to calculate it.
The first way is a simplified method that’s based on the size of her office. Usually, all Abigail need do is multiply each square foot of dedicated office space (up to a maximum of 300 square feet) by $5. Her annual deduction tops out at $1,500, dropping to $750 for an office of 150 square feet.
The second way is more complicated. Abigail has to multiply all of her home-related expenditures by the percentage of her home that she uses as an office. Say her office takes up one-tenth of her rental home; she gets to deduct one-tenth of her rental payments; her write-off could be well north of $1,500.
IRS regulations allow Abigail to avail herself of the second method only if she completes Form 8829 (Expenses for Business Use of Your Home) and then transfers the amount on line 36 to Schedule C’s line 30.
The regs simplify the paperwork if Abigail opts for the simplified method. They permit her to skip Form 8829 and go directly to Schedule C’s line 30.
Should she trudge through all the calculations on Form 8829 (2020’s version has 43 lines)? Or should she skip them and opt for the simplified method? Whichever method Abigail selects, she nonetheless has to use her segregated space regularly and exclusively as a principal place of business.
To complete Form 8829, Abigail must make complicated calculations when, say, she incurs actual expenses that benefit both the business and personal parts of her home—such as rent payments or depreciation deductions if she owns her home, and insurance and utility bills. As noted, the allowable deduction goes to line 30 on Schedule C.
A top write-off of $1,500 may prove to be chump change if Abigail lives in an expensive locale like Los Angeles or Boston. When her write-offs greatly exceed $1,500 or her office is much larger than 300 square feet, it usually pays for her to use Form 8829.
When Abigail runs the numbers to see which method is more beneficial, she should be mindful of often-hefty annual depreciation write-offs for an office’s cost. Form 8829 allows depreciation deductions over a 39-year period for the share of the house (but not the land) allocable to the business. The simplified method bars such deductions.
When Abigail uses the 8829 form, she has to allocate mortgage interest and real estate taxes between personal use (the1040’s Schedule A for itemized deductions) and business use (Schedule C).
When Abigail opts for the simplified method, she doesn’t need to allocate. She gets to claim all of her allowable interest and taxes on Schedule A, subject to limits imposed by the tax cuts and jobs act that former president Trump signed near the close of 2017.
The drawback to use of the simplified method: She forfeits deductions for outlays that benefit the business part of her home—such as insurance premiums and utility charges. What about other normal expenses that are unrelated to business use of a home?
When Abigail uses the simplified method, she remains entitled to claim deductions on Schedule C for all unrelated expenditures. Some of the possibilities: postage, travel, supplies, printers, desks, chairs, and even enhanced lighting for Zoom calls.
Some final fine print. While Abigail is free to use either of the two methods, whichever affords her a larger deduction, once she selects a method for the year in question, she locks herself in. The IRS forbids a later change to the other method, though it does allow switching back and forth between methods from year to year.
Abigail uses more than one home with a qualifying home in the same year: The IRS says she can use the simplified method for only one home in that year. However, it does allow her to use the simplified method for one home and the 8829 form for any others in that year.