In this video, Stephen Morris from AdviseRE explains everything you need to know about the Home Office Deduction—one of the most commonly misunderstood tax benefits for business owners. Learn how to properly deduct home office expenses under IRS Code Section 280A, understand the difference between direct and indirect costs, and discover which areas of your home qualify (and which don’t!).
Stephen provides clear guidance on documentation requirements, common pitfalls to avoid, and practical tips to ensure your deductions stand up to IRS scrutiny. Whether you’re running a daycare, storing inventory, or simply managing your consulting business from home, this video will help you maximize your tax benefits responsibly and effectively.
TRANSCRIPT:
Hello everybody, I’m Stephen Morris with AdviseRE. Today we are going to present a topic that a lot of you I know are very focused on, especially when you start your business, and that would be the home office deduction, one of the most taken advantage of and misunderstood areas of tax law out there. In this topic, we’ll be talking about what you can do, I’ll allow it. and what you can’t do. That’s going to be a hard no from me. As it relates to Code Section 280 Cap A. Now as you know, one of the best advantages of having your own business is that there’s an opportunity for you to take costs that you normally would incur in your personal life and be able to convert those into a tax deductible outcome. This is great because it doesn’t require you to economically go out and spend more money in order to achieve a tax deduction. As I’m sure you’re aware, we never prescribe going out and spending money solely to save on taxes. We would like to be able to structure costs that you’re already planning to expend for your business to become tax deductible events. We would never go out and spend money solely just to save taxes. That works out to be a very bad economic decision and it’s not something that you’ll ever see us recommend.(…) With that being said, let’s dive into the specifics of what it takes to deduct costs relating to your home, your personal residence towards your business expenses.(…) Now the first issue is that 280 Cap A was specifically passed so that there are specific and stringent rules around being able to take personal costs like your home and being able to deduct these for business purposes. The IRS wants you to meet certain criteria in order for you to be eligible to take these home office expenses as a deductible. One specific exemption that the IRS would be more than happy to provide a deduction for you as it relates to your home office would be if you’re in the business of selling inventory and you’re using a section of your home to store that inventory, which then later you would ship out to your customers. That one’s totally fine as long as there is a clear and separated space in your home that is specifically used to store inventory, then that percentage of your property could be used as a home office expense. Other notable ones would be things like if you’re running a daycare out of your home, then those costs as well could be related to home office deductions as well as if you’re using an area of your home specifically for your trader business like just an office, then this too would also be deductible for home office expenses. One thing to keep in mind is if you just started your business and you are pre-revenue, in other words, you’re not making any profit, then these home office expenses would only be limited to the amount of gross income that you have. Let’s take an example here that you earn in the first year $10,000 of net income before considering a home office deduction, but you have $15,000 in home office deductions. We can only use 10,000 of it towards the $10,000 in net income from your business to get you to zero. The remaining $5,000 would be carried forward in the future years.
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Let’s talk a little bit more about the use of your home and what areas are acceptable and what are not. A lot of folks come to me and they say, “Hey, you know what, Stephen? I really enjoy working in the living room and I also enjoy working in the kitchen, and so I’d like to be able to deduct the cost of the living room, the kitchen, and also I work in my bedroom, so there’s that.” Let’s say 70% or 80% of the home is being used for my home office deduction purposes, so I’d like to take 80% of the cost of the rent or the mortgage towards this particular area. I have bad news for you, that’s not going to work. Specifically in the code states that that area of your home that is exclusively used for trade or business would be deductible. In other words, sometimes you probably cook your own meals in the kitchen, therefore that’s out. The living room, most likely you’re accepting guests and you’re doing personal things in the living room like hanging out with friends and whatnot. Again, the living room’s out.(…) Generally speaking, what we’re talking about here that would be eligible for home office deduction would be something along the lines of a spare room that is converted into an office or a separate structure like a garage. Those are great examples of home offices, whereas the living room or the kitchen or any of the other areas that you would share for other purposes are generally going to be out.
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Now the question I know you all are asking is, “How would they know?” Well, that’s what an audit’s for. And so we have seen in the past and through case law that the IRS has come to visit taxpayers’ homes and observe what the home office situation looks like. And if it seems reasonable, it’ll allow the deduction. And if it seems completely unreasonable, well, then they’ll disallow the deduction and they’ll add back those deductions to your taxable income. And of course, they’re going to assess you on interest and penalties because they were expecting those tax dollars in those previous years. So my encouragement is that you don’t have to be exact or perfect in terms of your measurements, but it’s got to be reasonable.(…) You really can’t be using the majority of your home here for a deduction just because you happen to work in various areas of your property. Also another thing to keep in mind, there are expenses that are directly related to your home office that would be specific just for the home office, where there are indirect expenses that relate to the entire property, which we would then allocate a percentage of to be able to be deductible. So for example, a direct expense might be chairs, desks, or some sort of wall coverings that are specific for your home office. Those would be direct expenses and could be eligible for 100% deduction. Whereas indirect expenses would be things like the rent. That’s a great one. If you’re only using 20% of your home, then it’s natural to assume that 20% of your rent would then be deductible, not the full 100%.
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Property taxes, utilities, cleaning costs, repairs and maintenance, all these types of things as well would be considered to be indirect costs and they would be allocated based on a percentage of actual business use for the purposes of deduction for home office purposes.(…) Now the form that we use to report this, if you are a Schedule C filer, would be Form 8829. Now if you have an S Corp or a C Corp or any of these other things, then we’re not going to use that form. In fact, that will just be a normal rent expense that will fall onto the corporate tax return. And most likely what you’re going to have to do is have some sort of rental agreement between that entity and you and the entity will be paying you for the use of your home as a business expense. So with that in mind, what are some best practices? Number one is documentation. We want to see a lot of good documentation around what the home office looks like. We want to have a reasonable allocation, right? So we don’t want to again talk about using 50% plus of the property unless there is a certain or very special circumstance like for example, half your home is covered in inventory. Fine, we can take that. If it’s just an average consulting business where you’re just on your laptop talking with clients, you know, you’re probably not going to use much more than 20% of your property more realistically. The more I can show to an IRS agent to show that your home office is being used properly and it’s being allocated in accordance with the code, better chance we have not been investigated further and them accepting these charges. So if you found this discussion useful or if you have any further questions on the home office deduction, then feel free to reach out to us here and we’ll be happy to get back to you as soon as possible. Thanks so much for watching and look forward to seeing you in our next video.
