The home office deduction: myths and must-knows

The home office deduction offers a valuable tax break for the self-employed, freelancers, and independent contractors. Learn about the deduction and how it may reduce your tax liability.

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The home office deduction: myths and must-knows

Article | November 28, 2023 | Authored by KDP LLP


The home office deduction offers a valuable tax break for the self-employed, freelancers, and independent contractors. However, what appears to be a straightforward tax deduction is often entangled in myths and misconceptions and demands careful consideration. In this article, we aim to dispel some prevalent misunderstandings and highlight some of the lesser-known aspects of this deduction. 

The deduction is not for occasional remote work

The IRS doesn’t generously hand out home office deductions to everyone who occasionally sends a work email from their living room couch. For a space to qualify, it must be used regularly for business. It also needs to be the primary place where you conduct business. If you rent office space elsewhere and only use a home office a few times a year, it is unlikely to meet the IRS’s “regular use” requirement. 

Additionally, if you receive a W-2 from your employer, this deduction isn’t for you (even if you work from home). The home office deduction is for individuals who primarily earn their income outside of the traditional employer-employee framework. 

A computer in the kitchen does not make your kitchen deductible

The mere presence of a work device in a multifunctional space doesn’t automatically render the whole area deductible. For a deduction, the space must be a distinct area dedicated exclusively to business. 

The IRS envisions a home office as an area separate from regular living spaces, dedicated solely to business activities. Essentially, the home office deduction is all about clear boundaries. Your workspace should be easily distinguishable from your living space. It doesn’t have to be an entire room, but the line between work and personal use must be well-established.

Home daycare facilities are subject to special rules

Daycare providers who operate out of their homes are in a unique position when it comes to the home office deduction. Given the nature of their business, the IRS recognizes that these providers may not be able to meet the strict “exclusive use” requirement, so there are tailored provisions for home daycare operations. 

First, daycare providers can claim a deduction for areas used for the daycare even if that same space is used for non-business purposes at other times. However, the space in question should be used on a regular basis for daycare. This means that sporadic or occasional use does not qualify. 

Also, to qualify for the daycare-specific home office deduction, you must have the necessary approval as a daycare provider. This could be a state license, certification, registration, or inspection, depending on local regulations. 

The deduction is usually calculated based on the percentage of your home used for daycare and the amount of time it’s in use. For example, if you use 30% of your home for daycare twelve hours a day, five days a week, you would calculate your business use percentage accordingly. 

Consider your deduction method strategically

The IRS offers two main methods for calculating the home office deduction: the simplified method and the actual expenses method. 

Simplified method

The simplified method is relatively straightforward and offers a standard deduction of $5 per square foot of home used for business, up to 300 square feet. This is typically best for those with single-room offices or smaller operations.

Actual expenses method

The actual expenses method is a bit more intricate, as it considers a portion of your entire home expenses, but it might yield a larger deduction. Generally, this deduction method is best if your business occupies a significant portion of your home or if your home expenses are particularly high. 

With the actual expenses method, you can deduct both direct and indirect expenses, including depreciation. 

  • Direct expenses: costs directly related to the home office, such as painting or repairing the office space, are fully deductible.
  • Indirect expenses: these pertain to general home expenses, such as mortgage interest, insurance, and utilities. Their deduction is proportional to the size of your home office in relation to your entire home. For instance, if your home office is 300 square feet in a 2,000-square-foot home, 15% of your indirect expenses can be deducted.
  • Depreciation: allows for the gradual recovery of the property’s cost over time, reflecting its wear and tear. To calculate your depreciation deduction, you’ll need to know the fair market value of the property at the time you first used it for business and refer to the depreciation tables for the current year in Pub. 946.

To calculate your deductible expenses using the actual expenses method, use Form 8829, but note: it is detailed and requires thorough documentation. 

Your deductions cannot exceed your income

One of the most overlooked aspects of the home office deduction is the gross income limitation. This limitation means that your home office deduction cannot exceed your home-based business’s gross income minus other business expenses unrelated to your home (e.g., advertising or supplies).  Basically, the IRS wants to ensure individuals aren’t using the home office deduction to create or increase a business loss. 

But, there is good news if your home office expenses exceed this limitation and you use the actual expenses deduction method. While you may not be able to deduct the excess in the current year, you can carry it forward to the next taxable year, provided your gross income limit for that year allows for it. 

Tread carefully with the actual expenses method

While the actual expenses method can potentially yield higher deductions, it comes with its own set of caveats. Among these is the potential impact on capital gains if you sell your home. 

For most homeowners, if you’ve lived in your primary residence for at least two out of the five years preceding its sale, you can exclude $250,000-$500,000 of profit from capital gains tax (depending on your filing status). However, if you have taken home office deductions using the actual expenses method, this can interfere with the capital gains exclusion. 

Under the actual expenses method, homeowners must account for depreciation. When you sell your home, the depreciation you’ve claimed isn’t eligible for the capital gains exclusion. This is known as depreciation recapture. So, if you’ve claimed depreciation on 20% of your home for your office, 20% of the profit from the sale might be subject to capital gains tax. 

If you plan to sell your home in the near future, you’ll want to weigh the immediate tax savings against the potential cost of depreciation recapture. However, if you envision a long stay in your current residence, the benefits of the actual expenses method might outweigh the eventual costs. Over extended periods, the cumulative tax savings could eclipse the potential tax hit from depreciation recapture. 

Leveraging the home office deduction to its fullest while avoiding potential pitfalls requires careful consideration. This article provides a brief overview of the home office tax deduction and is not a substitute for meeting with one of our expert advisors. Before making any decisions, it’s wise to meet with one of our advisors, who can guide you through the regulations and ensure you’re adhering to all IRS rules while maximizing your deductions. For more information, please contact our office. 

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Call us at (541) 773-6633 (Oregon), (208) 313-7890 (Idaho) or fill out the form below and we’ll contact you to discuss your specific situation.

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KDP is a team of CPAs and business advisors with a local focus, but a national reach. We have offices in Medford, Oregon and Boise, Idaho, as well as satellite offices throughout the United States. We have been providing professional tax, accounting, audit, and management advisory services since 1976, serving clients nationwide. Our firm has more than 90 trained professionals on staff dedicated to furnishing high-quality, timely and creative solutions for our clients.

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What is operational resiliency and why is it important?

Operational resiliency: anticipate, prepare, respond, recover from disruptions, ensuring core services.

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What is operational resiliency and why is it important?

ARTICLE | November 21, 2023 | Authored by RSM US LLP

Skyscrapers are designed to sway. If they were too rigid, high winds or earthquakes would crack their structures. They are built to be resilient under all kinds of unforeseen conditions.

Similarly, an organization cannot afford to be rigid and inflexible. Successful companies are resilient.

Operational resiliency is a company’s ability to anticipate, prepare for, respond to and recover from unanticipated disruptions while continuing to deliver its core products and services. Creating resiliency is a proactive endeavor that focuses on building an organization’s capacity to absorb shocks and adapt swiftly to evolving circumstances.

Companies with a high degree of resiliency can withstand unexpected challenges or even full-blown crises. The key is to create a business model that is powerful and efficient, yet adaptable enough to address the sudden problems—anything from cyberattacks to natural disasters to supply chain disruptions—that can plague a business.

But how does a company accomplish that?

Assess the situation

Many third-party organizations provide business motion analyses, which gather information about a company’s level of resiliency. This type of analysis examines relevant criteria across an organization, such as the company’s industry, strategy, governance, communication approach, decision-making structure and other factors, coupled with a deep systematic study, now AI-driven, of the movement and flow of tasks, activities and information within the organization. The outcome identifies inefficiencies, bottlenecks and areas for improvement to optimize the overall performance and effectiveness of the business operations. A thorough analysis will also provide an objective look at how prepared a company is for an emergency.

This analysis does not necessarily identify specific threats. Instead, motion analysis assesses if the company is ready for the day when something goes wrong.

The dangers of being unprepared

Companies that lack resilience put themselves at risk for a host of problems, including the following:

  • Financial losses—negatively affecting cash flow
  • Massive downtime—alienating customers
  • Reputational damage—causing time-consuming crisis management
  • Regulatory noncompliance—leading to fines and consent orders
  • Shaken confidence of stakeholders—devaluing the brand and company

In some cases, a lack of resiliency could even mean the end of the company altogether. It’s crucial, therefore, to understand the components of operational resiliency and how to enhance them.

Risk management

There are several pillars that support the concept of operational resiliency. Perhaps the most foundational of these is risk management.

A comprehensive understanding of potential risks consists of identifying a company’s vulnerabilities in processes, systems, suppliers, partners and external factors, then assessing their potential impact. By obtaining a clear view of these risks, organizations can create targeted strategies to mitigate them.

A well-structured risk assessment can incorporate everything from testing a company’s cybersecurity to analyzing geopolitical issues that could disrupt the organization’s functions, among other factors. Potential risks can be obvious or hidden, major or minor, direct or indirect. In all cases, the resilient company has completed scenario planning that at least considers the possibility of these risks becoming a reality.

Business continuity

Companies must maintain their essential functions even during a crisis. This involves formulating contingency plans, establishing alternative work sites, designing flexible processes and implementing communication protocols to ensure seamless collaboration among employees and stakeholders.

For example, natural disasters cannot be contained. However, resilient organizations find a way to keep working even when Mother Nature wants to shut the company down.

It’s not just about assessing worst-case situations. It is about running through scenarios, coming up with solutions and being prepared to implement them when disaster strikes.

Data management

Technology plays a crucial role in operational resiliency. However, many organizations suffer from siloed data that is stored across different systems, and in such cases, vital information goes unused or unexamined. Embracing digital transformation enables organizations to quickly adapt to changing conditions and to make decisions in real time.

Redundancy in critical systems, regular data backups and strong cybersecurity measures are vital to prevent, or recover from, cyberattacks or technical failures. In addition, new tools are being developed constantly, and companies need to keep up to date on the best systems to bolster their resiliency.

Perhaps more importantly, access to real-time insights—gathered from the volumes of data collected and stored—enables management teams to make critical decisions quickly when faced with the unexpected.

Proactive leadership and culture

Resilient organizations are led by individuals who make thoughtful and data-driven decisions under pressure and guide their teams through challenging times. Adaptive leaders foster a culture of trust, preparedness, open communication and timely decision-making, which are essential in times of crisis.

As with every aspect of leadership, the tone that is set becomes contagious. Flexible leaders inspire flexibility in others within the organization. Leaders who panic provoke more panic. Resiliency is a trait that filters down through a company.

The resilient organization

Operational resiliency is not a luxury. It is a necessity for companies that want to stay relevant in today’s dynamic business environment.

By identifying risks, building sound strategies and fostering a culture of adaptability, organizations can navigate crises with strength and agility. Operational resiliency equips businesses to overcome challenges and emerge even stronger than before.

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Call us at (541) 773-6633 (Oregon), (208) 373-7890 (Idaho) or fill out the form below and we’ll contact you to discuss your specific situation.

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This article was written by RSM US LLP and originally appeared on 2023-11-21.
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