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Home Office Deductions - Owning vs. Renting

by
Gordon W. McNamee
on
12/20/2016
Home Office Deductions - Owning vs. Renting

The home office deduction is one of the most valuable tax benefits available to freelancers and small business owners who can prove that they have regular and exclusive use of their home workspaces. However, this deduction works differently when you own your home than when you rent it. Note: This article assumes that the actual expense method for computing the home office deduction is used. An alternative method (the simplified method), which is available to both renters and homeowners, applies a fixed dollar amount to a maximum of 300 square feet of home office area in lieu of actual expenses, and is not discussed in this article.

Direct & Indirect Expenses

There are two types of home office expenses: direct and indirect. Most expenses will be indirect in that they apply to the entire property, but only a percentage is deductible, based on the portion of the home used. Examples of indirect expenses are rent, insurance, security systems and utilities. Direct expenses apply only to the work area, and are 100% deductible, and include costs such as having the area cleaned or painted. 

Both direct and indirect expenses are similarly deductible for renters and homeowners with some chief differences in housing-related expenses. 

Home Office Expenses  

Taxpayers who qualify to claim a deduction for business use of their home can generally deduct the following indirect expenses as part of the home office deduction based upon whether they rent or own their home.  

Prorated Expense Own Rent
Mortgage Interest X  
Property Taxes X  
Rent   X
Homeowner's Insurance X  
Renter's Insurance   X
Utilities X X
Depreciation X  
Home Maintenance X X

Home Office Income Limitations

The home office deduction is limited to the gross income from the business activity.  Many mistakenly believe the limitation is the net income from the business activity. The gross income limitation is actually the gross sales less the cost of goods sold, business portion of home mortgage interest and taxes and otherwise deductible business expenses not related to the business use of the home (Publication 587 includes a worksheet).

Example: The percentage of expenses due to the business use of your home is 20%. You have the following expenses.

  • Deductible mortgage interest (20%) ............................ $1,500
  • Real estate taxes (20%) ........................................................... 1,000
  • Total........................................................................................................ $2,500

Expenses not related to business use of the home (100%):

  • Supplies ..................................................................... $500
  • Advertising ................................................................ 1,300
  • Telephone ................................................................. 200
  • Total ............................................................................... $2,000

Otherwise nondeductible expenses:

  • Home Maintenance (20%)....................................... $200
  • Home Utilities (20%).................................................... 350
  • Home Insurance (20%)............................................... 250
  • Total ....................................................................................... $800
  • Depreciation (20%)....................................................... $1,600

Based on the above expenses, you figure your deduction limit as follows.

  • Gross income.................................................................................................................................................... $6,000
  • Less:
  • Deductible mortgage interest (20%)........................................................................... $1,500
  • Real estate taxes (20%)............................................................................................................ 1,000
  • Expenses not related to business use of the home (100%).......................... 2,000    4,500
  • Deduction limit ................................................................................................................................................. $1,500

Note: If the home is rented, the interest and taxes would be replaced by the rental expense. 

Rent vs. Own The Home and What Happens If You Move or Sell The Home

When you rent your home, move and use space at the new location as a home office, for the year of the move you'll need to figure the deduction separately for each home office based on the specific expenses and business use area of each home. If you don't use space at your new living quarters for business purposes, then your home office deduction for the year of the move will need to factor in just the expenses for the time you lived in the first home.

On the other hand if you own the home, sell it and lived in it for two of the 5 years prior to the sale date, you can exclude up to $250,000 of gain ($500,000 for a married couple). However, you cannot exclude the part of any gain to the extent of depreciation you claimed for the home after May 6, 1997.

For the exclusion purposes, it makes a difference whether the home office was within the home itself or in a separate structure on the same property. If within the same structure, the exclusion will apply to the entire gain from the home. If the office was within a separate structure then the sale must be treated as two sales, one for the home and one for the office, and the gain from the office portion cannot be excluded.    

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Gordon W. McNamee

Gordon W. McNamee

Gordon W. McNamee is a Certified Public Accountant (CPA) based in Rancho Cucamonga, CA. Gordon W. McNamee can assist you with your tax return preparation, payroll, accounting and tax planning needs. <br /> <br /> 2021 is Gordon W. McNamee, CPAs 38th year in the profession. As as a former IRS agent (1984 through 1987), Gordon has been in public accounting since 1987. Gordon specializes in individual, corporate, HOA, trust, estate and payroll taxes. He also prepares financial statements and provides accounting & bookkeeping services. He enjoys making his clients feel at ease while providing a personalized professional service.

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