The Covid-19 pandemic pushed many to work from home. And that reality begs an obvious question: Do any of these people get a Covid-19 home office deduction?
In many cases, the answer is “yes.”
But the rules get tricky…
The Home Office Deduction in a Nutshell
Section 280A(c)(1) of the Internal Revenue Code creates the home office deduction. In a nutshell, the rule says that a taxpayer may deduct expenses related to the business use of a home.
The list of potential expenses includes mortgage interest, real estate taxes, repairs and maintenance, rent, utilities, insurance, and most other home expenditures you can make. You also get to depreciate some of the purchase price of your home if you own one. (You will “pay back” this depreciation later when you sell probably.)
But two critically important wrinkles to note up front. First, in general, you take the home office deduction, including Covid-19-triggered deductions, as a business expense. That means a taxpayer usually needs a business tax return (like a Schedule C) to take the deduction.
And a second wrinkle? You deduct only a percentage of this spending. Specifically, you calculate the percent of your home you use for your business. And that’s the percentage you deduct as a business expense.
A handful of examples shows how the deduction works.
Example 1: You pay $10,000 of mortgage interest and $2,000 of property taxes. Your home office uses 10 percent of your home. You can therefore count 10 percent of the mortgage interest, or $1,000, and 10 percent of the property taxes, or $200, as business expenses. Probably on a Schedule C or Schedule F.
The leftover home expenses may still be deductible as itemized deductions.
Example 2: A business pays $10,000 in mortgage interest and reports $1,000 as a business expense. The remaining $9,000 can be claimed as a mortgage interest deduction (probably) if the homeowner itemizes deductions on Schedule A.
A depreciation deduction exists for people who own an house or apartment.
Example 3: Say you bought your home for $500,000 and that $110,000 of this price represents the land. That leaves $390,000 for the building. If you use 10 percent of the building as your home office, you can depreciate 10 percent of the $390,000, or $39,000 over 39 years. Work through that formula and you calculate $1,000 a year depreciation deduction. Probably on Schedule C or Schedule F. (The math goes like this: $390,000 × 10 percent ÷ 39 years.)
Tip: You can use a simplified method to determine a home office deduction. That simplified method? You just deduct $5 per square foot of home office (up to 300 square feet) and then you call it good.
Work from Home Office Deduction Requirements
Section 280A(c)(1) sets forth the requirements a business needs to meet to take a home office deduction. The home office must be
exclusively used on a regular basis—
(A) as the principal place of business for any trade or business of the taxpayer,
(B) as a place of business which is used by patients, clients, or customers in meeting or dealing with the taxpayer in the normal course of his trade or business, or
(C) in the case of a separate structure which is not attached to the dwelling unit, in connection with the taxpayer’s trade or business.
The key bits to note in the above language? Those words “exclusively” and “regular.”
The home office needs to be used exclusively in almost all cases for the business. And the use needs to be regular in all cases.
Note: The only times “exclusive” use isn’t required? When a wholesaler or retailer uses the home office to store its inventory or when the business operates a daycare.
How Covid-19 Changes the Home Office Deduction
Now let’s talk about the impact of Covid-19.
Mechanically, Covid-19 doesn’t really change anything at all about the home office deduction. Except you want to note one giant thing. For many taxpayers, state and local public health policies effectively moved your principal place of business.
In other words, sure, you may have rented an office. Or leased a retail shop. Or even bought some facility. And the plan may have been to operate from that location. But then, the pandemic hit. And somewhere along the way, elected leaders and appointed officials decided, no, you needed to close that location.
And at that point, arguably, your principal place of business moved.
Note what this means. It may be that in prior years, you could not legitimately deduct home office expenses. Probably that inability stemmed from the fact your home office was not your principal place of business.
Covid-19, though, changed that for many small business owners.
Further Into the Weeds
A handful of additional comments about those statutory requirements…
First, a home office counts as the principal place of business if you use the office for administrative and management work—and you don’t have some other location to do that work. It’s okay, by the way, if you do a little bit of administrative or management work someplace else. Tax rules say the “incidental” stuff doesn’t count. (Again, though, ask yourself whether due to Covid-19 public health policies you were actually able to work from where you had earlier planned.)
Second, if you meet with customers, clients, patients—the people who pay for your products or services—you don’t need your home office to represent your principal place of business. For example, you could have an office downtown where you meet with folks three days a week and then an in-home office in your suburban home where you meet with people two days a week. And that’s okay. (This isn’t really a Covid-19 angle. But you want to know the rule.)
Third, finally, if you have a separate structure like a garden shed you converted to an office or studio, that works for a home office deduction. Even if you have some other principal place of business. For example, if you use a converted garden shed for a workspace regularly and exclusively, you don’t need to have that space also be your principal place of business. (In some areas, you hear that lots of Covid-19 work-from-home folks did this. They moved their workspace into a garden shed. But this angle may really matter more after the pandemic. In other words, working from home in a separate structure? That may be a way to play the home office angle going forward.)
Limitations on Covid-19 Home Office Deductions
Unfortunately, tax law limits the way home office deductions work.
And the limitations may surprise work-from-home folks who haven’t previously deducted home office expenses.
For example, partners in partnerships? Yes, they can get the home office deduction to work. But the partnership agreement needs to require them to work at home. (In this case, the partner reports the home office deductions on her or his tax return as unreimbursed partnership expenses. These deductions appear on the Schedule E, page 2 form.)
Employees working from home due to Covid-19? They probably won’t get to add a home office deduction to their tax returns. The reason? A regular W-2 employee files no business tax return on which to put the business expenses connected to the home office.
But an exception to this rule exists. You can deduct home office expenses as unreimbursed employee expenses if you “qualify as an Armed Forces reservist, a qualified performing artist, a fee-basis state or local government official, or an employee with impairment-related work expenses.” Check out the IRS guidance if you think any of these situations apply.
Note: Employees prior to 2018 sometimes got to use unreimbursed employee expenses as miscellaneous itemized deductions if they itemized their deductions using Schedule A. But that loophole largely disappeared at the end of 2017.
Finally, home office accounting rules may limit deductions based on the income of the business. The rules work like this. Mortgage interest, property taxes, and casualty losses ignore whether the business makes money. But you can’t use any of the other home office expenses (like insurance, utilities, repairs, and so on) to create a loss.
This limit based on the business income may be especially relevant (and painful) in this time of Covid-19. Many small firms have suffered severe reductions in revenue—which may have lead to losses which in turn prevent Covid-19 home office deductions.
The IRS provides a special form to calculate and claim a home office deduction for a Schedule C sole proprietorship. You will want to review both the actual form, Form 8829, and the companion instructions. By the way, the form and its instructions make for helpful reading for partners who want to take an unreimbursed partnership expense deduction for a home office.
You may also be interested, if you own an S corporation, in how the home office deduction works for S corporation shareholder-employees. A post at our Evergreen Small Business blog explains that: S Corporation Home Office Deduction Revisited.