Home office deduction

[WiseOne]

I've been researching a bit about this, and thought this would be a topic of general interest...

I am not currently claiming the home office deduction for my side business, because I was worried about the fact that I'm employed full time and my employer provides an office. Plus, I heard it's a red flag which ups the likelihood of an audit. My business is also sporadic, a grab bag of little jobs that come my way: expert opinions on legal cases, honoraria for lectures, federal grant review panels - so not sure it really meets the criterion of "regular".

However, there's an interesting twist to the story. My department, in all its dysfunctional glory, is happy to take the indirects from my NIH grants but provides no space outside of my office. My lab includes two postdoctoral fellows, a graduate student, and occasionally also medical students and visitors. It's a "dry" lab so we really only need space for desks/computer stations and storage of supplies and equipment (about $600,000 worth of major equipment bought on an NIH large equipment grant, plus random small things like disk drives).

Currently, the equipment is sitting in a dry lab space in another department, where it's liable to get poached. I have occasionally squeezed it into my office. The postdocs and graduate student have been working from home, and we use my office for joint meetings once a week plus one on one meetings. They really like this setup, and especially enjoy the lab meetings I hold at my apartment - more comfortable, food provided, comfortable space, fluffy friendly cats etc.

It occurs to me that I could try to turn this situation to my advantage. I like working from home as much as my postdocs do, and as I'm only a 15-20 minute walk from work there's not much reason not to do it. If I claim that my office is actually equipment storage and on-site meeting room, rather than a true office, then my home becomes the main office. Of course my department still considers it "my office" though. Also, it would be great for my postdocs to claim the home office deduction as they spend most of their after-tax income on rent, and between that, associated expenses like cell phone & computers, and state/local taxes they might possibly break the standard deduction barrier.

Would like to hear thoughts from people who have explored the home office deduction in detail.

[farjean2]

I took the home office deduction for several years but I stopped when I discovered that the portion of your house that you declare as a home office is not eligible for the capital gains waiver when you sell your home. Don't know if that is still true but it was back then. So it was a case of the government giveth and the government taketh away and I concluded it wasn't worth the potential hassle when I sold the house. When I ended up selling it the formula looked so complicated I just filed without it and hoped they wouldn't notice. They didn't and it's been over 15 years so I guess I'm safe.

[Libertarian666]

I would incorporate your side business. Then you can claim pretty much any reasonable business deduction, and you can also set up a profit-sharing plan to stash away retirement savings.

[clacy]

I would take the deduction (I do currently as well). It's no longer a "red flag" item within the IRS per my CPA.

It may have been reasonable to red flag that deduction at one time, but with the availability of technology and the sheer amount of people working from home, it's no longer an issue.

If you have a legitimate side business with actual revenue, your full time job should have no impact whatsoever, unless you're already taking the deduction for your job (can't double dip for the same space).

[jhogue]

I was a history professor until I retired last year and claimed the home office deduction for the past decade. I was never audited, and never worried about any "red flags."

I think the key to the home office deduction is to make absolutely sure that your designated office area is both for the "exclusive use" and the "regular use" of your business. Consult your tax professional, but I think what you described fits both criteria.

In my case, I used my home office to conduct historical research for publication of books and articles. I don't think it matters that you have another university office. I used my university office to prepare classes, meet with undergraduates, and do committee work for required university administration. I also used my home office to house my personal professional library consisting of several hundred books. I did not hold regular graduate seminars in my home office, but I had at least one colleague in my department who did. Sorry but cats don't count and ridiculous as it may sound, if you keep kitty crates in your office, zealous IRS agents (are there any other kind?) could regard that as a violation of the "exclusive use" rule. Will the cats be upset if you move them to your living room?

Beyond your office, I also kept a spreadsheet detailing my deductible travel expenses, in conjunction with my research at archives and academic conferences promoting my work. I did not file to create an LLC and never thought it necessary, given that most of my payments were for royalties documented in form 1099s. The IRS has a publication devoted to instructions for Schedule C line-by-line and I recommend you read that over carefully as well.

[Xan]

I take it. So far it's been great. farjean is right that the capital gains exemption doesn't apply, but at least for me, that's far outweighed by the deduction each year. Based on the percent of your house that's your office, you can deduct that percentage of all your utilities, all your maintenance (AC repair, yardwork, you name it), housecleaning, and of course rent/mortgage (but not the mortgage interest, since you're [probably] already deducting that).

One big thing: be SURE to take the deduction for depreciation on the house as well. You're required to pay that back when you sell (assuming the house hasn't actually depreciated). The snag is you're required to pay it back whether you took it or not. That doesn't make a lick of sense to me but that's the way it is. It all will make for some significant extra math when selling, unless you take the farjean approach and ignore it completely, which is quite intriguing...

[Maddy]

If I claim that my office is actually equipment storage and on-site meeting room, rather than a true office, then my home becomes the main office. Of course my department still considers it "my office" though. Also, it would be great for my postdocs to claim the home office deduction. . .

Nobody could argue that you don't have a bona fide business separate and apart from your regular job, or that an office space is both ordinary and necessary to the type of self-employment in which you are engaged. A home office dedicated exclusively to that business is more than reasonable and, in my view, is not likely to ever be challenged.

On the other hand, claiming that a portion of your home is your "office" for purpose of your primary employment strikes me as failing the "straight face" test. Not only does the characterization strike me as just too cute (a term of art denoting a painfully strained argument), but if push came to shove your employer would not corroborate your characterization of the situation. Under IRS standards, the fact that your employer does, in fact, provide an office space for your use in conjunction with your employment--however inadequate it may be--alone pretty much tanks the argument.

Since claiming the home office deduction for a space used exclusively for your side business is a pretty straightforward application of the business-use-of-home rules, why press your luck with an alternative characterization that requires such a long stretch?

P.S. I think you're reading too much into the word "regularly." If your home office is the place you keep reference books, journals, old case files, lecture notes, billing records, and works in progress, I'd submit that even though you don't physically occupy the space every day it's nonetheless being put to regular use. The fact that the nature of your work legally requires you to maintain strict confidentiality standards (i.e., you can't have medical records just sitting around on your kitchen table for the cat sitter to peruse at will) simply bolsters that conclusion.

[WiseOne]

Thank you all!

Maddy you're right about just limiting to side business (and yes, keep records, books and files in the office area - no kitty accouterments). I figure my postdocs are on more solid ground with that, as they truly do not have any assigned space. This being Manhattan though, the office area is a sectioned off space (defined by doorways and furniture) and not a separate room. Hope that will suffice.

Interesting question of how the value of the deduction compares to the capital gains taxes you'll eventually have to pay when you sell (apart from the farjean method). Time to fire up the calculator.

Let's assume that the home office deduction decreases my taxes by $500 per year excluding depreciation, while my home is worth $500,000 (not actual costs but ratio is more or less correct). Now assume that the office is 10% of home space. For that 10% portion, I would have to pay capital gains at 20% on profits from the sale. That means that if you sell after one year, you'd have to make a profit of $25,000 in order for the capital gains tax to wipe out the home office deduction. Consider that the break-even point. This would represent appreciation of $25000/$500,000 or 5% per year, ignoring closing costs.

I consider depreciation to be a zero sum game if you have to pay it back upon selling, meaning that it's essentially a long-term loan at 0% interest and should not figure into the above calculation.

Real estate prices in my neighborhood are on fire right now, but I can't see sustained increases averaging 5%/year. So it sounds like the home office is a win. Definitely will start claiming next year! I think good idea to take a photo for documentation purposes.

[dualstow]

Interesting.
I take it. Initially, I had to supply some figures to my accountant like the size of the home office in proportion to my home. Now, it's out of my hands.

[Maddy]

Thank you all!

Interesting question of how the value of the deduction compares to the capital gains taxes you'll eventually have to pay when you sell (apart from the farjean method). Time to fire up the calculator.

Let's assume that the home office deduction decreases my taxes by $500 per year excluding depreciation, while my home is worth $500,000 (not actual costs but ratio is more or less correct). Now assume that the office is 10% of home space. For that 10% portion, I would have to pay capital gains at 20% on profits from the sale. That means that if you sell after one year, you'd have to make a profit of $25,000 in order for the capital gains tax to wipe out the home office deduction. Consider that the break-even point. This would represent appreciation of $25000/$500,000 or 5% per year, ignoring closing costs.

There's now a simplified method for figuring your home office deduction. As I recall, you get $50 per square foot, up to a maximum of 300 square feet--yielding a maximum deduction of $1,500 per year. The beauty of this method is that it requires no record-keeping aside from that necessary to establish your entitlement to the deduction. Germane to your concern about future capital gains issues, I seem to recall reading that the simplified method is not intended to take account of depreciation and does not result in any reduction of your home's basis. So my question would be whether utilizing this method would allow you to take the deduction without any worry about future capital gains consequences. My memory is very vague on this, so you'd definitely want to do some research.

[jhogue]

1. A syllabus showing the dates of your weekly conference, subjects discussed, etc. should suffice to show regular use. You probably already do something like that anyway..

2. Turbotax software can calculate both the standard and the more detailed office deduction. Maddy is right that the newer standard version is simpler. You still might want to compute the more detailed version once and compare the two.

[Maddy]

This being Manhattan though, the office area is a sectioned off space (defined by doorways and furniture) and not a separate room. Hope that will suffice

"That's a partition you see there. It only looks like a scratching post."

[WiseOne]

There's now a simplified method for figuring your home office deduction. As I recall, you get $50 per square foot, up to a maximum of 300 square feet--yielding a maximum deduction of $1,500 per year. The beauty of this method is that it requires no record-keeping aside from that necessary to establish your entitlement to the deduction. Germane to your concern about future capital gains issues, I seem to recall reading that the simplified method is not intended to take account of depreciation and does not result in any reduction of your home's basis. So my question would be whether utilizing this method would allow you to take the deduction without any worry about future capital gains consequences. My memory is very vague on this, so you'd definitely want to do some research.

I couldn't find anything about this online - most interesting question. The simplified deduction would be a LOT smaller than the full deduction in my case, so it may be that it won't cover the later tax hit.

Another interesting wrinkle in simplified vs. full deduction: the mortgage interest and property taxes. These are deducted in full on Schedule A in the simplified method, but in the full deduction method you have to account for part of this in the home office deduction. This means that you save on self-employment taxes. You also only get to deal with depreciation in the full deduction method, and if you can't use it all your home's basis is still decreased by the depreciation amount which is a problem.

[Maddy]

From the IRS website:

Highlights of the simplified option:

Standard deduction of $5 per square foot of home used for business (maximum 300 square feet).
Allowable home-related itemized deductions claimed in full on Schedule A. (For example: Mortgage interest, real estate taxes).
No home depreciation deduction or later recapture of depreciation for the years the simplified option is used.

https://www.irs.gov/businesses/small-bu ... -deduction

I assume that you come out ahead under the regular method primarily because of the depreciation deduction which, under the regular method, is later recaptured. Because there is no recapture under the simplified method, the benefits of the two methods might turn out to be pretty comparable.

[farjean2]

... unless you take the farjean approach and ignore it completely, which is quite intriguing...

I think it would probably only have a chance of working if you quit taking the deduction for a sufficient number of years before you sold the house like I did.

I figured the worse that could happen is that I'd get a letter from the IRS telling me I owed the taxes which is something they have no problem doing as I've gotten letters like that before. I would have just said oops, sorry, and cut them a check.

[jhogue]

Our discussion of the home office deduction sent me rummaging through old tax returns.
A couple of points:
1. Re-looking my schedule C’s, I noted that my home office deduction amounted to a rather small percentage of my overall roster of expenses. I had forgotten that in a number of years, other Sched. C expenses exceeded my overall revenues, before home office expenses. In that case, the home office deduction could not be taken. This was not necessarily a bad thing, given that a negative Sched. C. number lowers gross income on the front side of Form 1040. The bottom line here is to keep in mind that these kinds of small businesses come in all shapes and sizes and it is hard to generalize.
2. I did not live in relatively high cost location, did not have a mortgage, and did not have high property taxes (relatively speaking). Quite the opposite of WiseOne’s real estate situation in New York, IIRC. Given all of that, it would seem that the home office deduction is even more potentially valuable and she should therefore not settle for the simplified home office deduction that the IRS introduced several years ago. The effort to capture the data (ie., mortgage interest, depreciation, utilities, maintenance, etc.) supporting the home office deduction should be rewarded. Beside all of that, once you do a Schedule C, it makes it much easier to do in the outlying years.

[Maddy]

I take back what I said when I speculated that depreciation would probably account for the lion's share of the deduction. I blanked on the fact that WiseOne was in New York City and failed to appreciate how insane the real estate and tax situations have become there. Doesn't everybody live in a paid-off cabin in the woods? Funny how we interject our own frame of reference into situations without even being aware of it.

[jhogue]

I take back what I said when I speculated that depreciation would probably account for the lion's share of the deduction. I blanked on the fact that WiseOne was in New York City and failed to appreciate how insane the real estate and tax situations have become there. Doesn't everybody live in a paid-off cabin in the woods? Funny how we interject our own frame of reference into situations without even being aware of it.

Maybe everybody should live in a paid-off cabin in the woods.

Right on time, here is a link to a new article about rising numbers of Americans working from home:


https://www.fidelity.com/insights/marke ... -home?ah=1

[Libertarian666]

I take back what I said when I speculated that depreciation would probably account for the lion's share of the deduction. I blanked on the fact that WiseOne was in New York City and failed to appreciate how insane the real estate and tax situations have become there. Doesn't everybody live in a paid-off cabin in the woods? Funny how we interject our own frame of reference into situations without even being aware of it.

Maybe everybody should live in a paid-off cabin in the woods.

Right on time, here is a link to a new article about rising numbers of Americans working from home:


https://www.fidelity.com/insights/marke ... -home?ah=1

I've been able to do that once in awhile even though programmers should be able to do it full-time.

For some reason, most employers still don't want to let people do this even when there is no technical reason that they can't.

[Maddy]

The whole work-at-home thing--that would make an excellent thread in its own right. When I moved out here, I constantly heard from the "locals" that I'd last for three years and then move back to the city--that people just can't make a living here unless they bring a job with them. I've lasted eight, working mostly from home and nearly always as my own boss. It helps to be able to trade food for food, but alas, my insurance agent wasn't impressed with my offer of payment in raspberries. I have spent some time on various websites looking at more structured work-at-home opportunities. Apparently there are many of them, but there are also a lot of scams. It's something I plan on looking at more closely when things slow down.

[farjean2]

I've been able to do that once in awhile even though programmers should be able to do it full-time.

For some reason, most employers still don't want to let people do this even when there is no technical reason that they can't.

I worked entirely at home as a programmer when I was an independent contractor for about 10 years. I liked it at first but after ten years I was ready to get a full time job and go back to working in the office every day with regular hours. The main thing I missed was quitting time when you hop in your car and go home. When you work at home you're always at work. The other thing was the social interaction. We had a lot of people working from home in my last few years before I retired and I never even got to meet most of them in person. We would just spend a few minutes on the phone every day at most. The project manager might refer to us as "the team" but it never really felt that way to me. I think there is something to be said for working with people face to face and that's probably why a lot of employers want you in the office.

[WiseOne]

A paid off cabin in the woods is more attractive right now than you can imagine! Maddy, I'm surprised when you say you can't find things to do online remotely. What about online tutoring or document/grant editing? With your credentials it should be easy to get onto the major online sites for these. Once you establish a history with clients, you could probably strike out on your own and skip the middleman to maximize income. There's also the option of running an ebay store, if you happen to have a convenient post office or UPS pickup nearby. And is there some low-stress way to make use of your legal experience, e.g. by doing wills and real estate contracts locally?

For NYC yes, the simplified deduction makes zero sense, as it underestimates actual expenses by a factor of 5 apart from depreciation. The fact that nearly all my home expenses are rolled up in the maintenance bill makes the bookkeeping for the full deduction quite easy. I know of one person who purposely bought an apartment with low sale price and high maintenance because it would maximize her home office deduction.

[jhogue]

1. It seems more than coincidental that the IRS formulated the new “simplified” home office deduction in the midst of an ongoing boom in working from home. Also not coincidental is that our back-of-the-napkin calculations suggest that the “simplified” home office deduction will yield a significantly smaller figure than the full home office deduction. The IRS probably can’t keep up with the boom and decided, in effect, to offer a compromise to taxpayers with side businesses. Has anyone on the forum ever actually been audited, or knows someone who has been audited, for their home office deduction?

2. This forum has been dedicated to the proposition that all investors are created equal and can dispense with expensive investment advisors. I know I certainly feel that way. But do people feel the same way about tax advisors? Or, are taxes an area where expertise actually makes a difference?

[Maddy]

Maddy, I'm surprised when you say you can't find things to do online remotely. What about online tutoring or document/grant editing? With your credentials it should be easy to get onto the major online sites for these.

On-line tutoring is something that would really appeal to me. Same with writing and editing. (Lord knows, I've done enough persuasive writing in my time to qualify.) I just had no idea that there was any significant demand for remote services other than [gulp] customer service.

Recently, somebody raised the topic of on-line teaching. I was stunned that there was such a thing, but apparently on-line education has become very popular. I wonder what technologies you need to master to be able to do that. Things like Skype, webcams and webinars are mysterious concepts that cause the luddite in me to come out. Maybe it's something that could be worked out if I had some IT help.

I've done a little dabbling in on-line selling (sourcing from garage sales, thrift stores, and such), and it's been a rather fun, low-stress way of making extra money. I have to admit, working bent over in the blazing sun for the equivalent of $3 an hour is much harder on me than it was five years ago. I do believe (and perhaps you could confirm) that the human brain is capable of boiling.

THANK YOU, WiseOne, for the ideas.

[WiseOne]

I don't at all mind turning this into a thread on working from home. I've discovered the joys of doing this 1 or 2 days a week when I'm not on a clinical service, and I love it. I feel like I spend less time actually working BUT I get a lot more done than I would at the workplace. One of my research mentors told me he's done this for years and strongly recommended it.

I bet jhogue is right that the new simplified home office deduction is designed to make life easier on tax auditors while reducing the value of the deduction for people who take it. I have no idea where in the country housing might cost only $5 a square foot per year. That would be a monthly rent of $400 for a 1,000 square foot apartment, for example. South Dakota maybe?

Maddy - have fun exploring the online freelance options (e.g. tutor.com). I'd looked into those for a bit of side income, that is before I started getting requests for expert medical opinions (to defend academic MDs from malpractice suits...a good cause). They provide you with a side income but not full benefits - for that you'd need a real job, which would come with all the stresses and loss of control that made you leave your city & law firm nest to begin with. From your previous posts, you really have enjoyed working on your farm, despite the physical hardships. Where do you stand on that now?