What if I told you it was possible to write-off half of your personal residence as a tax deduction? You’d probably ask me if that was legal and was there jail-time involved. Here’s the great news, it is entirely possible to do and within the framework of today’s tax code. For a resident of metropolitan NYC, this could translate to deductions of $30-50,000 or tax savings in the 5 figures!

Last week, I made the case for 2 compelling reasons to maintain an office in your home. One reason is for the home office deduction itself and the second reason is for the auto expense benefit. This article will cover how to maximize the home office deduction if you want to have a dedicated room or multiple rooms in your home for your office space. Next week, we will cover how to take the deduction with the smallest possible space for the purpose of unlocking the auto expense deduction benefit.

There are two very important rules to cover. The first is that the home office must be exclusively used for the business. This means that you cannot use a guest room that only has guests a few times a year, the personal use a few times a year, removes the exclusive use requirement. There are of course exceptions to every rule and a day care and storage are the exceptions to this rule, please consult a tax professional like myself before claiming a mixed use space.

The second rule is that it must be the principal place of business. This rule causes a lot of business owners to think they are not eligible to claim this deduction if they have another office elsewhere. In IRC Section 280A(c) the tax code uses this language “as the principal place of business for any trade or business of the taxpayer” and then clarifies with this statement:

For purposes of subparagraph (A), the term “principal place of business” includes a place of business which is used by the taxpayer for the administrative or management activities of any trade or business of the taxpayer if there is no other fixed location of such trade or business where the taxpayer conducts substantial administrative or management activities of such trade or business.

If you use your office in the home as the primary location for any administrative or management function for example bookkeeping or HR activities then it qualifies.

Now that we know you can maintain an office in the home and qualify to deduct it as a business expense, let’s talk about how the allocation of home expenses gets allocated.

In IRS Publication 587, the IRS says that “you can use any reasonable method to determine the business percentage” of your home that you use for business. The publication provides 2 examples of such methods:

Gross square footage: Divide the area of the home used by the office by the total area of your home.

Number of rooms: If the rooms in your home are all around the same size, you can divide the number of rooms used for the business by the total number of rooms.

One method that I end using for many of our clients is not listed in the publication but is a common method for accounting for space and is the net square footage method. In this method, you calculate the interior area of each room in the home, excluding bathrooms, hallways, etc. You then total the usable areas as the denominator and use the area used for business as the numerator. This very often results in the best outcome because you have eliminated the space between the walls, the hallways, bathrooms and closets which were included in the denominator in the Gross square footage method.

If you have a home with 3 floors and your downstairs is not used for personal use and is finished as one big open area, using the net square footage area, that one floor which is 1/3 of your home could end up being 50% of the usable area of the entire home, creating a very lucrative tax benefit for you.

As you can see, there is a lot of thought and calculations that go into something that seemingly seems basic like the home office deduction. Without this knowledge, you could follow the form instructions and end up leaving a lot of money on the table. It pays to have a tax professional that is willing to take the time and ask the right questions to create these tax saving opportunities for you.

I will close the article with one final point. If your business is setup as a S-Corporation for tax purposes, then you cannot deduct the home office deduction using the tax forms on a personal income tax return. The method that should be used is the employee reimbursement method. Some may advise you to use the rental method but this would be a mistake. If you fall into this category, give my office a call so we can help you take the deduction correctly.