By Mark E. Battersby / Published December 2018
Today, working from home or taking work home is quite common. However, merely having a home office or space within the home used as an office doesn’t mean an automatic tax deduction for the expenses of operating it. What’s worse, today fewer are eligible for the home office expense deduction.
Under the Tax Cuts and Jobs Act (TCJA), employees can no longer claim the home office expense deduction. For employees, even employees of their own pressure cleaning business, home office expenses have long been a miscellaneous itemized deduction. Unfortunately, thanks to the TCJA, employees who work from home can no longer deduct home office expenses. Of course, the self-employed and anyone who runs a business from home using part of their home for business purposes may still use the home office expense deduction.
For those still able to take advantage of the home office expense deduction, qualifying is relatively straight-forward. In general, part of the house must be used in the following ways:
Unfortunately, while appearing relatively easy to meet, some of these requirements are interpreted strictly by the IRS. First, as mentioned, the home office expense deduction applies only to a business. Managing investments is not a trade or business in the eyes of the IRS.
Using the space labeled as a home office exclusively for business is, as mentioned, a basic requirement. Space being used as the principal place of business and used “regularly and exclusively” is defined as follows:
In addition to regular and exclusive business use, the home office must be the principal place of business.
The principal place of business requirement is fairly broad and doesn’t mean “only.” In fact, the home office will qualify as the principal place of business if it is used exclusively for administrative or management activities—and if there is no other fixed location where substantial administrative or management activities of the pressure washing business are conducted.
Of course, if there is more than one business location, the relative importance of the activities performed at each place where business is conducted must be considered along with the amount of time spent at each site.
Examples of activities the IRS and the courts consider as administrative or managerial in nature include the following:
Regular and exclusive business use as the principal place of business for the pressure cleaning operation isn’t the only criteria acceptable to the IRS. Among other factors that enter into the equation are these:
Capital gain of up to $250,000 ($500,000 for married couples filing jointly) can be excluded or ignored when a principal residence is sold. However, in order to qualify for this exclusion, an ownership test must be met.
An individual or couple is eligible if the home has been owned and used as the main home for at least two years out of the five years prior to the date of sale. If, however, the property was used partly as a home and partly for business, and the home office isn’t a separate structure, gain doesn’t have to be allocated between the home part and the business part.
Naturally, no part of the gain relating to depreciation allowed or allowable (after May 6, 1997) will qualify for exclusion, even where the home sale itself qualifies for the exclusion. The depreciation recapture (so-called Section 1250 gain) is taxed as ordinary income but at a rate that is no more than 25 percent.
The rules are different if a separate structure is used for business. Deductions for business storage are allowed when the home is the only fixed location of the business. Exclusive use isn’t required to qualify for the deduction.
However, gain resulting from the sale of a separate structure cannot be excluded because the property must have been owned and lived in for at least two years during the five-year period ending on the date of sale.
However, if the business use was in a separate structure and the use test was met, an allocation of the gain on the sale must be made. Any resulting gain must be reported as well as any recapture of depreciation allowable or taken.
Every contractor, dealer, distributor, or supplier thinking of qualifying for and claiming the home office expense deduction has two options. The first option for calculating the home office expense deduction is the regular method.
The regular method requires computing the business use by dividing the expenses of operating the home between personal and business use. Direct business expenses are, obviously, fully deductible with the percentage of the home’s floor space used for business applied to indirect total expenses.
Although expenses for the non-business portion of the home are not deductible, expenses for such things as the business portion of real estate taxes, mortgage interest, rent, casualty losses, insurance, depreciation, maintenance, and repairs are deductible home office expenses.
The so-called “simplified method” reduces the paperwork and recordkeeping burden. The simplified method uses a flat rate of $5 per square foot for business use of the home. There is a maximum allowable deduction based on up to 300 square feet that places a ceiling on the total amount deductible as a home office expense at $1,500.
Choosing the simplified method merely requires completing a short worksheet and entering the result on the annual tax return. With either method, self-employed contractors file Schedule C, Profit or Loss from Businesses, and compute this deduction on Form 8829, Expenses for Business Use of Your Home.
An increasing number of folks are working at home or operating a business from their home, and now they have the option of a new “safe harbor” deduction for home office expenses. Whether space in the home is used as a home office for a pressure cleaning business that is based there, or if the home office is used to supplement the business’s primary place of business, a tax deduction may be available.
Regardless of the method used to compute the home office expense deduction, business expenses in excess of the operation’s gross income are not deductible.
Obviously, the tax deduction for maintaining a home office and the related expenses provides a valuable tax-saving opportunity for the owners of any pressure cleaning business as well as for self-employed contractors who work from home. While the TCJA eliminated many deductions formerly claimed as miscellaneous itemized deductions on personal income tax returns, the home office expense deduction continues to apply to the business.
The IRS continues to encourage all small business owners to explore the guidelines surrounding the home office expense deduction and the options available. They are reminding everyone that the home office expense deduction applies only to a business, with the option of deducting proportionate operating costs or using the new “simplified” method.
Fortunately, a legion of professional advisors stands ready to help every self-employed contractor and pressure cleaning business owner as they attempt to navigate the complex and often confusing rules surrounding the home office expense deduction—and the tax saving possibilities.