One of my favorite tax perks available to real estate investors is the home office deduction.
Let’s face it, the home office deduction is generally not going to reduce your tax bill down to zero. However, it can still provide you with quite a bit of tax savings if used correctly.
How to Analyze a Real Estate Deal
Deal analysis is one of the best ways to learn real estate investing and it comes down to fundamental comfort in estimating expenses, rents, and cash flow. This guide will give you the knowledge you need to begin analyzing properties with confidence.
3 Reasons I Love the Home Office Deduction:
1. No Additional Money Out of Pocket
Unlike most tax deductions, which require you to actually spend money or invest in something, the home office deduction does not require any additional money out of pocket. What you are simply doing is shifting what would otherwise be personal nondeductible expenses into legitimate business tax write offs.
For example, if you repainted your entire house for $8,000, there would be zero tax deduction if you did not have a home office. On the other hand, assuming your home office accounts for 25% of your entire home, this means that $2,000 ($8,000 x 25%) is now a legitimate tax deduction.
2. Easy to Claim
Unlike certain expenses that need advanced planning or strategies, there is generally no advance planning needed for a home office deduction. There is generally nothing you need to do ahead of time and nothing you need to do before the end of the year.
Even if you already filed your tax returns for last year and this is the first time you realize that you qualify for the home office, you can simply file an amended return for last year to claim a tax refund.
3. New Simplified Calculation
Effective January 2013, the IRS came out with a simplified method for calculating home office write offs. If you are not someone who keeps good records, this can be the answer you have been looking for!
One of the benefits of the new simplified method is that rather than keeping receipts and calculating the actual expenses, you can instead use the IRS standard $5 per square foot to determine your home office deduction. Under this method, you can deduct eligible home office of up to 300 square feet.
This means a total annual write-off of up to $1,500.
I am still surprised that a large percentage of people I meet do not take their eligible home office deduction. A big part of this problem is that there is a lot of mis-information out there regarding the home office deduction.
Let’s go over what the rules are and separate the truth from the myths.
3 Home Office Deduction Myths & Truths
1. Exclusive Use
First, you must use that part of your home exclusively for business purposes. You need to have an area in your home where you work solely on business activities — and nothing else. This means that if you have a room or an area within a room where you review your property management reports that should qualify.
On the other hand, if you use your dining table to work from every day, this would generally not qualify as a home office because your dining room would also be the place where you eat. Now, I know that some of you may tell me that you never eat from your dining table and that you only work from there. My advice is that even if that is the case, I still would highly suggest not claiming your dining room or dining table as your home office as there have been court cases where the IRS has successfully challenged this particular area within the home.
2. Primary Place of Business
The second rule that must be met in order to be eligible for a home office is that this must be your principal place of business. Notice the wording used by the IRS is “principal” place of business and not the “only” place of business.
One of the common mistakes we see is people who don’t take a home office deduction if they have another office that they can go to from time to time. Keep in mind that you can have other offices and still claim a home office deduction. Your home just needs to be the primary place in which you conduct your business.
Here is a great example: I recently met with a client who has some out of state rentals. He has a property management company that takes care of things on the ground. As an investor, all he does is review the management reports and manage the manager from his home office. In the past, he never took a home office deduction because he was told that his home was not the primary place of business because the property management company was located out of state and they were the ones managing the properties.
This was absolutely incorrect. Your home office just needs to be your primary place of business. So as long as you are managing your properties from your home office, the fact that you have property managers out of state won’t disqualify you from having a tax deductible home office.
3. Audit Risk
Last but not least, one of the most common myths on home office deductions is that it is an IRS audit flag. That is a very outdated concept. In fact, research shows that close to half of Americans have home offices that they work from sometime during their lifetime.
If you still believe that the IRS is out to get you for claiming the home office deduction, it is time to update your thinking. Not only has it been shown that home offices are no longer a red flag audit item, the new simplified method the IRS introduced in 2013 should show you that they are now in agreement that the home office is a valid deduction and they want to help make taxpayer’s lives easier.
Have you used the home office deduction on your taxes before? Did you learn anything you didn’t know about this aspect of tax law?
Jump in on the comments below!