The home office deduction provides a nice deduction for individuals who work from home. This is particularly helpful if you have a run a home based business. You can deduct a portion of your mortgage (or rent), utilities and other related expenses. The beauty of this is that you get to deduct a percentage of the items you have to pay anyway regardless of the business.

Seeing how the home office deduction can be so beneficial to taxpayers, the IRS pays close attention to these deductions – this deduction will increase your audit risk. However, this should not discourage you from taking the deduction if it is legitimate. The two major requirements that the IRS is looking for is 1. The home office must be used regularly and exclusively for business and 2. Your home office must be your principal place of business. If you meet these two requirements you can likely take the deduction.

To figure the deduction you must determine the square footage of your office (or business area) and divide that by the total square footage of your home. This will provide you with a percentage that you can use to calculate your deductions.

   Example:

Total Home = 1,000 Sqft

Home office size = 100 Sqft

Percent of home expenses that are deductible = 100/1,000 = 10%

Total Mortgage Interest $12,000, Total Utilities $1,500

Deductible Mortgage Interest (allocable to home office) = $1.200 ($12,000 x 10%)

Deductible Utilities (allocable to home office) = $150 ($1,500 x 10%)

For tax years ending after 12/31/13 the IRS has come up with an easy calculation to determine the home office deduction (IRS Revenue Procedure 2013-13). The new home office deduction (option) allows for taxpayers to deduct $5 per square foot for their home office. With this method the office is capped at 300 square feet or  $1,500. Given that this cap is fairly low, it will likely be beneficial to track expenses and calculate the traditional way.

A home office deduction can also be taken as an unreimbursed business expense by employees. To qualify for this deduction the home business use must be based on the convenience of the employer, and the employee may not rent their home to their employer and use that portion as an employee.

The employee’s deduction is a miscellaneous itemized deduction (on Schedule A) and is subject to the 2% of AGI limitation (i.e. you only get to deduct the amount that exceeds 2% of your AGI). Example: if your AGI is $100,000 and your un-reimbursed home office expense is $3,000. You will only be able to deduct $1,000 on Schedule A. So the home office deduction is more beneficial to self-employed individuals.

To read more about the home office deduction guidelines visit the IRS website.