Have you seen my stapler? (photo credit)
After visiting 16 countries in 16 months we are back in Taipei, Taiwan for the next year or so. A rental property we stayed in awhile back was available once again and the landlord was happy to have us move back in. It always pays to be a good tenant.
Even better news, this apartment has a room we used only for storage. So I turned it into a tax deduction.. err, I mean a home office.
What is a Home Office?
Any space in a home can be used for a home office as long as it is:
a) used exclusively and regularly
b) the principal place of business
In our case, the space is an extra room. I could also take over our balcony or segment the master bedroom with a screen divider (sleep on one side, defined workspace on the other.)
The key is the space must be exclusively for work. It can’t also be a play space or a guest bedroom. Work and only work.
This is OK. Jr sleeps with us, so we don’t need a 2nd bedroom (yet.) All of his toys are in a super cool hand made toy box in the living room. (OK, it is really a cardboard box, but it is his favorite toy.)
Best. Toy. Ever. No parking in the office.
Any guests can sleep on our very comfortable sofa. (I vouch for it’s comfort. It’s very nice.)
The other key is that the space must be used regularly. Not daily, not hourly… regularly. I write blog posts regularly. I reply to comments regularly. Now I just do those activities inside these 4 walls. Excuse me, while I step into my office.
Speaking of offices, I have no employer or other location where I’m required to be. Therefore this room is my principal place of business. (Note: employees have additional restrictions on deducting a home office. In this post I’m specifically looking at the self-employed / business owners.)
Meeting all of the requirements for a home office, I am now able to deduct related expenses on our taxes.
Home Office Tax Deduction
The IRS allows two methods for deducting home office expenses.
a) Actual Expenses
b) Simplified Method
We can calculate using both methods and use whichever provides the largest deduction. Or be lazy.
Actual Expenses
To determine actual expenses, it is required to mathematically separate a home into personal and business components. This is done by measuring the size of the work space relative to the size of the total home.
A 200 sq. ft. office in a 2,000 sq. ft. home is able to deduct 10% of actual home ownership costs as a business expense. This includes mortgage interest (or rent), insurance, utilities, and more… even depreciation. See IRS Publication 587 for the juicy details. Or if you dislike IRS docs, TurboTax has a summary explanation. (Depreciation can be messy business, so be sure to understand the implications. This is one reason we intend to be Renters for Life.)
For homeowners, high mortgage costs and deprecation can generate insanely large home office deductions, only limited by the profit of the business. (It isn’t OK to generate paper losses to offset other income.)
One important point with this method: keep extensive and detailed records. Personal Capital is a free tool that we use to track all of our business and personal spending (affiliate link.)
Personal Capital expense tracking. Business Expense tag
Simplified Method
Maybe that seems like a lot of work, and you would prefer an easier method.
How much is 1 sq. ft. of your home worth? The IRS says $5, with a maximum size of 300 sq. ft. (This is especially cool if you live in a really low cost of living area.)
Take the size of the home office, multiply by 5, and that is the total home office business deduction. A 200 sq. ft. office is worth a $1k deduction.
Simple. And Lazy… I like it.
My New Office
My new office is cozy, about 100 sq. ft. (146.5 in x 98.5 in.) The $2 measuring tape I purchased is also a tax deduction, since I couldn’t calculate my home office deduction without it.
Documentation
Unfortunately using the simple method I can only get a deduction of $500 (~$42/month.) But our rent is $1000/month and the office is a full 10% of total square footage, for a monthly deduction of $100.
I can also claim 10% of all of our utilities, except primary landline phone (which we don’t have.) That varies based on A/C usage, but AFAIR last time in this apartment it averaged ~$100/month. 10% or $10 of this is tax deductible.
Our housekeeper also spends 10% of her time cleaning the home office. $15 of the ~$150/month cleaning bill is also a deduction.
By using the Actual Expenses method, and keeping extensive and detailed records, I can deduct ~$125/month. It looks like I’ll be keeping records after all.
One important record, particularly if you move often, is photo evidence.
Before
Man at Work, Business as Usual
Tax Savings
With a 15% marginal tax bracket and 15.3% SE Tax, a $100 deduction saves a real $29.15 in taxes (1/2 of the SE Tax is income tax deductible.)
Or… for every $100 deduction at the 15% federal marginal rate, I can increase the size of our annual Roth IRA conversion by ~$195 with no difference in tax due. (The deduction saves both SE and Income taxes, whereas the Roth conversion is only subject to income tax.)
With a $125 monthly deduction we’ll save ~$36 in tax (~$440 annually.)
Summary
By exclusively and regularly using a dedicated space in your home to conduct business, the rent or ownership costs of that space can be deducted. In our case, it is an extra room. It could also be a partitioned corner of a larger room with a screen divider (also tax deductible.)
The home office deduction is a great way for business owner’s (aka side hustlers and the self employed) to reduce their Self Employment and Income taxes.
Do you have a Home Office? Can you make one?
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Great tax deduction if you can take it…
My office space disappeared when our second child came along…a problem you might run into one day to Mr. GCC. :)
I do like the idea of screening off a larger room — That isn’t something I considered previously!
With you guys traveling around so much, is this a realistic deduction when you’re only in one place for a few months at a time?
We’ll be staying more or less in one place for the next year or so, for reasons that may cause me to lose my office space. So yeah, realistic.
If this means what I think it does, congrats to you and Winnie!
Not yet, but working on it :)
Will this trigger TWD taxes now that you will be resident and earning in Taiwan for over half a year? Does that negate the value of the home office which theoretically you could give up by moving around more often?
Taiwan is a territorial taxation country*. Investment and business income from other countries isn’t taxed.
* If worldwide income is >$200k USD then an AMT applies.
Nice.
As usual a great post about how to maximize the system (I was going to say “game” but that has negative connotations).
Any chance you are interested in delving into partially disclaiming (i.e. passing to your children) the inheritance of Traditional IRAs in order to minimize total tax hit? This would have to get into the Kiddie Tax, which you’ve addressed in passing. I would love to read that post.
I like the word game. It reminds us that tax optimization is fun :)
Most of the content on this blog is stuff I’m trying to figure out myself. Neither one of us plans on dying anytime soon, so it might take me awhile to get interested in this. But check out Kitces, he’s written quite a few posts on strategies for inheriting / bequeathing IRAs.
Thanks for the pointer! I’ll head right over.
In the Netherlands, an office space at home is only recognized as such if it has a separate entrance from the street AND a separate toilet, too. But enjoy the fine American system, I would say!
The US tax system is definitely generous, especially relative to Europe.
This is another one of those “red flag” zones at this point in our (tax) life too. I work both from home (teaching online/consulting) but I also do enough work outside of home (temporary jobs) that I just don’t want to chance it at this point (with 10 rental units and all of the paperwork related to that too). We also plan to live out of two properties in the next few years (snowbirding for winter) – so that might complicate it too. Not out of the question though – just not ready to commit. We are at the other end of needing bedrooms for kids – in a few years, a home office will easily find its way into both our homes!
Sounds like you are entitled to a home office deduction, assuming you are self-employed. A lot of people work outside the home (plumbers, landscapers, electricians, etc…) and can claim the deduction because do administrative work in their home office.
Great Post! Perhaps you can also give us details into how you can deduct traveling expenses for business, such as food, entertainment and hotels. I understand it’s also a percentage as well, depending how much of it is for business and how much of it is for pleasure. I would be very interested in learning from you!
It depends. The primary purpose of travel needs to be business, but everything is nuanced. This article is a pretty good overview.
I also touch on this a bit in regards to our FinCon trip.
I’ve never taken the home office tax deduction before because I don’t have a place that I use exclusively for business. Now that you know the tax deduction, how much money would you save to live in a similar apartment without the extra office room?
Dunno. We are already near the lower range of the rent curve. This neighborhood is mostly 3 bedroom apartments, but our was remodeled into a large master bedroom with an office.
Cracker –
Great post! I’ve used the home office deduct every year in the past – until we moved out of the country. I’ve never really thought about it here because I thought it only impacted mortgage (we don’t have one, we rent) and other US-type items. Didn’t realize I could track all of my normal house expenses – rent, utilities, cleaning, etc… and roll them up into my home office deduction.
Question – when you file your federal taxes, what address do you use? ie., where does the US believe you live? Does it matter really??
Thanks,
A
Hey Alan-
As someone who’s been filing overseas for years now, I think it doesn’t really matter. The IRS just wants to know where to send you mail. If you file the 2555 or 8965, then you have to specify which test you meet, but other then that, it’s not really relevant or of interest to the IRS, as far as I know.
The US taxes its citizens no matter where they are, so it doesn’t really matter. This year I’ll use my Traveling Mailbox address.
Great use of space! My mom just started using part of her home as an office for tax purposes but I never walked through the steps before. Question – does the IRS specify you have to be there working more than half the year – I only read the TurboTax link and couldn’t decipher what qualifies. With the amount of traveling you guys do would it make a difference or can you write off part of the travel as expenses too?
The IRS doesn’t specify. It just states that you need to use the office regularly and exclusively. People with 2 homes with one office in each can meet this requirement.
Travel deductions can only be deducted if business is the primary purpose of travel. For us, this is seldom the case (FinCon and Chautauqua being the exceptions.)
I wouldn’t bother with the documentation hassles to claim this deduction if we were always on the go. I’m only doing it because we intend to be in this one location for awhile.
Can you claim the home office deduction if you don’t own a business, but instead are employed at an organization that lets you work from home at least 50% of the time?
Only if it is for the convenience of your employer. That is usually interpreted to mean that you don’t have an employer provided office.
So in your example, no, you can’t deduct the home office.
If you worked from home full time and had no employer provided office, you could claim the home office deduction for expenses above 2% of AGI.
I use the simplified method and claim our office based on that $5/sf. I think it works out to a $1000 deduction which saves somewhere around $300-500 after you factor in ACA credit phaseout and IBR student loan payments plus 5.75% state income tax. Not sure how I could run a successful home based business without it!
Did you do the math to see which one came out ahead? Or the simplified method was easy and good enough?
Simplified method was good enough given the alternative of digging through records, adding it all up and taking about 10% of it. Without a mortgage and with our tiny $1500/yr tax bill, we just don’t have a lot of home-related expenses most years. I might be able to come out ahead in years where we replace a major component (like the roof) if that’s a permissible expense.
I also figure it was one more “safe harbor” where the IRS can’t challenge the $5/sf rate. Otherwise we dive down the rabbit hole of “does the ant killer I applied to the backyard get attributed to cost of maintaining the house/office or no?”.
Makes sense. Also, congrats on also being lazy ;)
btw, you can expense the ant killer and depreciate the roof. And your new windows. But probably not worth the effort since you are also at an effective 0% tax rate.
It’s worth it for the 15.3% SE tax savings and 5.75% NC state taxes (gotta love having a low income in a conservative state… and getting taxed to death)
I work from home and have an office, but have never been able to hit the 2% agi floor in order to deduct my home office expense.
I’m in the same boat– not enough to effect my AGI. Also, consider that claiming the home office deduction increases your chance of getting audited.
If you are an employee working at home for the convenience of your employer, you have to itemize on Schedule A and only employee expenses above 2% of AGI are deductible.
This isn’t what is happening here.
A business owner deducts the home office on Schedule C and isn’t subject to the 2% AGI limitation.
I’ve added a point to the post to clarify this.
There’s three points I don’t see mentioned in this post that seem germane to this topic:
1) converting part of your home to a business makes that same part of your home lose its capital gains exclusion upon the sale of that home
2) taking depreciation causes your basis in your office to fall leading to additional gain upon the eventual sale, thus potentially exacerbating #1 above
3) home office deductions seem to only start after you surpass 2% of AGI, thus lowering the cost vs. benefit of this strategy accordingly, particularly when weighed against both #1 and #2 above
GCC avoids #1 and #2 entirely by renting, but it seems that home owners should be wary of this strategy and conduct a full benefit vs future cost analysis before proceeding. Still might be a winner, but maybe not.
Yes, always do your own research. I’m just a random guy on the Internet.
But… some details of these 3 points are not accurate.
1) For a home office as described in this post, gain on sale is fully excludable. (What you are stating only applies if the office is a separate structure… a garage or outbuilding, for example.)
See Pub 587:
“If the part of your property used for business is within your home, such as a room used as a home office for a business or rooms used to provide daycare, you do not need to allocate gain on the sale of the property between the business part of the property and the part used as a home.”
2) This is correct. Depreciation is a deferral of taxes, not an elimination of them (unless the home decreases in value or you never sell.)
But this is one of the few cases where you can convert ordinary income to capital gains. Depreciation today eliminates both SE and Income taxes. In the future, recaptured depreciation is taxed as a capital gain (max 25%).
The deferral of taxes is a good thing (same as 401k) and it is a great thing when the future rate is lower.
Note to self: I should add messy depreciation to the list of reasons why we will be Renters for life.
3) The self-employed deduct home office expenses on Schedule C. There is no limitation with respect to AGI. (Employees working at home for the convenience of their employer can only deduct expenses exceeding 2% of AGI, and they must itemize deductions on Schedule A.)
Thanks Larz
Sweet strategy! Too bad I have no income to speak of right now. But maybe one day I’ll do some consulting or make some side income and can take advantage.
Income is overrated, imho.
Very helpful as I’ve been working from home almost full-time for a few years. Thanks!
Have you claimed the home office deduction?
It’s typically beneficial to utilize the deduction if you rent, but not if you own. If you own, then you’re losing out the tax free capital gain personal residence exclusion on that portion of the home when you sell….so a lot of people will play with their kids in their home office to make sure it is very clear that it is in fact a space used for business and personal.
but if you’re renting? Absolutely No reason not to milk it for what it’s worth.
I’m curious why you need to utilize this strategy though when you’re already taking advantage of the foreign earned income exclusion?
Hi TJ
We don’t claim the FEIE. We arrived at a 0% tax rate without it so it was better to not claim it and instead put 29k into Roth accounts completely tax free. (See 2015 tax return.)
You do NOT lose tax free gain on the home office when you sell. See Pub 587 and this Home Office Within Home example. As well, see my earlier reply to a comment with more details.
Thanks for linking the real deal! There was some reason I chose not to take it in the past when I had a side biz at home. Myth of greater chance of audit? Didn’t want to deal with depreciation repayment? Don’t remember, don’t really care. :-D
Myth is the right word. But nobody says you have to claim all deductions available to you, or that they are all worth the effort.
I’ve gone through the whole depreciation and repayment process. It can be a bit of a pain. But TurboTax does it all for you. Still, it is another reason I prefer to rent.
I actually did as well via turbotax! I sold my property lat year. happy to have liquidated all that capital out of real estate and placed into more productive assets. =)
There are a bunch of things associated with the simplified method that are beneficial – https://www.irs.gov/businesses/small-businesses-self-employed/simplified-option-for-home-office-deduction
A big one (timewise anyway) is depreciation deduction and recapture.
Very interesting! I actually started a new job this week that is mostly working from home. They gave me a home monitor and everything. I’ll need to see if I can get this deduction :). Thanks for the inspiration!
I’m looking forward to writing off our home office, since I started my business this year. Thanks for the overview.
Not a fiscal question, but a health one (thanks to your “before” photo): since you are settling in for a year or so, what are your plans for fitness? More bicycling? You did CrossFit in Thailand – do you plan to continue that? Just curious! :)
What, you don’t like my Dad bod? ;)
Funny thing… the day Julian was born I weighed basically the same as in the “before” photo. I’ve since put on a few lbs… the croissant, cappuccino, gelato diet in Europe didn’t help.
I’m back at Crossfit in Taipei, with some biking, walking, stair climbing mixed in for fun.
The before picture of the ROOM you doof! It looked like an elliptical and a bike were stored in there.
Yeah, I seldom / never used those. I very much dislike riding and running in place while indoors. In any case, the owner has reclaimed them, probably to store in an extra room at their new place :)
If you use a home office for an LLC you are a member of, does it still work as a write off for your personal taxes?
Yes.
Great info. I’ve been following your posts and happy to report that my Tax guy is finally understanding… Who do you use for your taxes or do you do them yourself?
I do my own tax prep. I explained a bit of the reasoning in 2 posts:
Who Does Your Taxes?
The Fear Tax