A mistake many real estate agents make: Failing to properly deduct a home office
By Paul Dion, CPA CTC
Just about any accountant will tell you the home office deduction is probably the most misunderstood deduction in the entire tax code.
For years, people were afraid the home office deduction raised an automatic red flag for auditors. But Congress has relaxed the rules and now it’s far less likely to attract attention. And even if you are audited, as long as your ducks are in a row, why worry?
Let’s start with the basic premise. Your home office qualifies as a place of business if:
- You use your office exclusively and regularly for administrative or management activities; and not or, and
- You have no other fixed location where you conduct substantial administrative or management activities of your trade or business.
The rule applies even if you have another office so long as you don’t use that other office more than occasionally for administrative or management activities. (So, if your broker provides an office space but you almost never use it…you should be fine).
Okay, that’s a mouthful. Let’s break it down into simple terms.
First, you have to use your office regularly and exclusively for business. “Regularly” generally means at least 10-12 hours per week, but that depends on the nature of your business. Since real estate agents spend a ton of time outside the office showing houses, checking out properties, networking…the key is that when you do need to perform clerical and administrative tasks, you regularly use your office for those purposes.
But if you only use the office a couple times a year, don’t expect it to quality.
And, your office must be used for business purposes only. If you use the space for personal reasons, too, it is not deductible (e.g. your office doubles as a home theater or rec room).
If you’re only using part of a room, you don’t have to partition off your workspace in order to deduct it (partitioning might be helpful if you are audited). A desk in the corner of a room can qualify as a workspace as long as you count only a reasonable amount of space around the desk as your “office” square footage.
If you meet both those tests, it also helps to keep a log showing the time you spend in the office in case you are audited.
If your space qualifies, start deducting expenses. (Sole proprietors use a specific form; if you’ve set up an S-Corp, there is no separate form required.)
Here’s how you determine what you can deduct:
- Calculate the square footage of your home office. If your office is 10’ x 10’ room, the total square footage is 100 square feet (10 ft x 10 ft=100 square feet). If you’re only using a portion of the room, measure the space you are using and multiply accordingly.
- Determine the total square footage of your home. (that number should be on an old appraisal or tax bill).
- Divide the area of your office by the area of your house. For example, if your home is 2,000 square feet and your office is 100 square feet, your home office takes up five percent of the total space. (100/2,000=.05.) Five percent is the percentage of your home expenses that can be written off under the home office deduction.
Now list all your home expenses and start multiplying. You can deduct five percent of:
- Rent, mortgage interest, insurance and property taxes.
- Utilities, repairs, garbage pickup, security, etc.
- Your home’s basics (excluding land) over 39 years as non-residential property (In other words, five percent of your home qualifies as a commercial property that can be depreciated.)
You can use your home office expenses to shelter profits, but not to the degree that you end up with a loss. If that happens, you can carry forward those losses to future years to offset higher income.
Here’s an extreme example: Say your home office deductions add up to $1,500, but you only make $1,000 this year. You can offset earnings and carry the “excess” $500 to next year.
One caveat: When you sell your home, you’ll have to recapture any depreciation you claimed or could have claimed after May 6, 1997.
And you can still claim the $500,00 (that’s if you’re married; it’s $250,000 if you’re single) tax-free capital gains exclusion when you sell the home as long as the home office space was not considered a “separate dwelling unit,” like a separate structure located elsewhere on the property.
The key is to accurately determine the percentage of your home allocated for business use, and keep a record of all home expenses that you deduct a portion of. Like any other tax planning strategy, keeping accurate records is critical.