More and more employers are now allowing their employees to work from the comfort of their own homes. While this is convenient for many workers, it also allows them to take a tax deduction for their home office expenses. This article will examine the specific costs that count as home office expenses, as well as the criteria that must be met in order to deduct them.

Exclusively and regularly used for business? 

The first question that must be asked about any home office in order for it's expenses to be deductible is, is the workspace used exclusively and regularly for business? The answer to both of these questions must be yes before any deduction can be taken.

If the workspace is used for both business and personal use, then it is not deductible. Furthermore, the space must be used on a regular basis for business purposes; a space that is used only a few times a year will not be considered a home office by the IRS, even if the space is not used for anything else.

These criteria will effectively disqualify many filers who try to claim this deduction but are unable to substantiate regular and exclusive home office use. It should be noted that it is not necessary to partition off the workspace in order to deduct it (although this may be helpful in the event you are audited.) A simple desk in the corner of a room can qualify as a workspace, provided you count only a reasonable amount of space around the desk when computing square footage.

An exception to the exclusive-use test applies to filers who provide day-care services for children or any type of adult dependents. In this case, the exclusive use test is applied differently, because obviously those receiving care are only there during the day. Therefore home daycare expenses are computed by apportioning out not only the square-footage of the home versus the area used for daycare but also the number of hours the area is used for daycare versus the number of hours in the year (8,760). Utility rooms such as laundry and storage rooms may be deductible under certain conditions as well.

For your employer's convenience? 

The second major test that must be met is whether your home office is solely for your convenience or the convenience of your employer. If your employer has provided a place for you to do business at its own location, then you cannot simply set up a home office for your own convenience and deduct its expenses. Your employer has to decide that you must work from home before your expenses become deductible.

There cannot be an alternative location available, at least on a regular, continuous basis. Both employees and independent contractors may have to prove this to the IRS via expense receipts and/or documentation from their employers stating that there is no workplace provided to them outside their homes.

Finally, filers with more than one home-based business must take care when claiming the home office deduction, because each of their different lines of business must meet the above criteria, on a standalone basis. If one line fails, then all others fail as well. It's an all-or-nothing proposition.

Calculating your deductions

Once all of the above conditions have been met, IRS form 8829 must be completed in order to compute the actual amount of deductible home-office expenses.

The first step in computing expenses is to determine the amount of square footage of the workplace and divide that by the total square footage of the home. For example, if your home office is a 15’ by 15’ room, and your home has a total of 1,600 square feet, then you will divide 225 by 1,600 to get 0.14. This decimal represents the percentage of your total home expenses that can be allocated toward the home office deduction.

Then you must list all of the expenses that pertain to your entire home, such as mortgage interest, real estate taxes, insurance, utilities and depreciation for the year under the section titled “indirect expenses” of form 8829. Expenses that are incurred solely for the benefit of the office space are then listed under the “direct expense” section of the form. The indirect expenses are totaled and multiplied by the percentage derived earlier, while the direct expenses are also totaled and added to the indirect expenses.

A final test that must be met here is the income test, which mandates that the total deductible expenses cannot exceed the income derived from the business for which the deductions have been taken. For example, if total deductions come to $1,200 and only $950 of income has been earned from the business, then only $950 of deductions can be taken for that year. However, the remainder can be carried forward to a future year and deducted when business income exceeds expenses. (NOTE: this summary of how expenses are calculated is only intended as an overview: for complete instructions on this matter, see the instructions for form 8829 on the IRS website at www.irs.gov.)

This final number is then carried to either the Schedule C for self-employed filers or form 2106 and then to Schedule A for employees. The latter group must also be able to itemize deductions, and then home office deductions are aggregated with all other unreimbursed employee expenses and must exceed a 2% AGI threshold in order to be deductible.