I qualify for the home-office deduction. What can I deduct?

If you own your home, deductions for home office generally are divided into three areas. See if you qualify.

You MUST apply all three areas in the order mentioned below. For example, if you qualify for the home-office deduction, you cannot take 100% of your mortgage interest as an itemized deduction—you must take a portion of the mortgage interest as a home-office deduction and the remainder that's not business use as an itemized deduction.

Here's how the deductions break out:

  1. Home-office expenses that would otherwise be deductible if not for the home office
    For example, home-mortgage interest expense and property taxes that would otherwise be itemized deductions. This doesn't apply if you rent your home.
  2. Other expenses related to the business use of the home
    Such as repairs/maintenance, insurance, and utilities related to the home office. This is the only thing that applies if you rent your home.
  3. Depreciation of the home-office space
    Note: You should always calculate and take depreciation expense. The reason is that when you ultimately sell the house, the IRS will require that you take into taxable income the amount of "allowed or allowable" depreciation—whether you took depreciation or not.

Your home office expenses might be all or partially phased-out for the current year if your home-office expenses exceed your net income

You're not allowed a net business loss deduction, because of a home-office deduction. So, if your small business had net business income of $1,000, you can only deduct up to $1,000 of home-office deductions—in the order shown above. The unused home-office deduction is carried forward to future years. Home-office deductions are reported on Form 8829.

Note: The IRS is sensitive to the home-office deduction, so double-check to make sure you qualify. You should be prepared to defend your position with the IRS. Home-office deductions can be a complicated area of the tax law, so please consult with your tax advisor or ask us the question.

Fin Tips

  • Be aware that converting a portion of your home to business will create additional taxable income, called "recapture," when the house is sold. The additional income is based on the amount of depreciation taken over the time that you've owned the home.
  • If your home office is a detached property, for example, a detached garage or detached in-law unit, the conversion to a home office could cause the detached property to be ineligible for the $250,000 gain exclusion* ($500,000 for married filing jointly) upon the sale of your principal residence.

* Gain exclusion: A taxpayer is allowed to exclude up to $250,000 ($500,000 for those filing married filing jointly) of the gain on the sale of their primary residence. To be allowed this gain exclusion you must have owned the home as your primary residence in 2 of the last 5 years before sale.