Ep. 17 | Home Office Deductions Explained
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Speaker 2:Welcome back to Teaching Tax Flow, the podcast, episode 17. Another fantastic topic I know a ton of you can take advantage of. You may think you know all the answers to this, but we guarantee you don't. And I only say that because my counterpart I guess, well, you know what? I'm not even gonna give you a big head this time.
Speaker 2:Forget that.
Speaker 3:Oh, come on.
Speaker 2:John I'm John Tripalskios, the Teaching Tax Flow, the podcast, and Chris Pacquero is here with me. What's happening, Chris?
Speaker 3:What's up, John? I'm excited about this episode. We're excited about all the episodes, aren't we? We
Speaker 2:are. So let's talk home office, but before that, who's supporting us?
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Speaker 2:So let's talk home office. So give a Chris, give us the definition of what defines a home office. I know you love it so much because everybody asks you, but here you go. One to many rules. Say it one time and everybody can hear it.
Speaker 3:Well, I would say the home office deduction is something that is very misunderstood as a practicing CPA of of twenty years plus years. I know I don't look a day that over, that I've been doing it ten years. Anyway
Speaker 2:You guys can't see me chuckling, but it it's happening.
Speaker 3:Yeah. And he's he's struggling. And you would be chuckling. There's that's why we have a face for podcasting. So but but the thing is, there are several people that we run into that should be taking the home office that are afraid to for some reason.
Speaker 3:There's some people that mistakenly take the home office that shouldn't. And and the bottom line is this is a deduction that's available to you if your if your primary work location is in the home. So there to me and and all these details are in the wonderful IRS publication five eighty seven, which I'm sure, John, you were perusing this morning.
Speaker 2:Oh, of course. I I've had my highlighter out. You know, I I was considering getting a getting a tattoo, you know, somewhere, get some more ink that says, you know, home office. No. Not it's not even a joke.
Speaker 2:Although we we do have some crazy nights. So leaving that alone
Speaker 3:So so home office yeah. So for a space to be eligible for the home office deduction, it has to be meet a couple criteria. First, it has to have regular and exclusive use. Second, it has to be your principal place of business. Regular and exclusive use, principal place of business.
Speaker 2:So before we skip off that, though, I'm I'm gonna interrupt you. Let's so let's talk about those two really, really quick. Okay? Regular and exclusive use. So let's split it into two.
Speaker 2:What ex what's the what's the good rule of thumb we should say as far as for regular? This can't be a place you use for an hour a year while you're on vacation and then try to take a full deduction. Right? So hit me with what regular is a good assumption.
Speaker 3:Correct. So regular means you regularly use the the space. The the, the IRS and publication five eighty seven doesn't come out and say you have to use an x amount of time. So it's regular and exclusive use, and it's also, regular exclusive use. That means that it doesn't this is a big misconception.
Speaker 3:The space doesn't have to be an entire room, but it has to be exclusive to business usage. So the fact that we might work on your you might put your computer on your kitchen counter and work there sometimes, That kitchen is used for a variety of reasons. However, let's say you had a you were fortunate enough to have a very large closet in your master bedroom, and your spouse did not have a large shoe collection, and and you had a growing family and you converted that closet into your office. In that case, even if two thirds of the closet was just an office and one third was for your clothing, then that would be regular and exclusive use for that portion of the home.
Speaker 2:Which is actually pretty interesting. If you if anybody has a little time and you wanna see some interesting designs and use of space, hop on Pinterest and type in, you know, closet offices or closet desks or hanging desks. People get super creative with this stuff, and I don't even think they realize what they're doing actually may qualify them for this type of deduction.
Speaker 3:You're right. And one thing that one thing also to consider is, remember, we said it has to be your principal place of business. It doesn't have to be your only place of business. There could there are people that have several places of business, but that term principal place of business is very important. And, typically, if you are someone that, works you you have a home office and then you you you drive different places or you do something consulting or or maybe you're a ride share driver.
Speaker 3:You know, we always like to talk about Uber drivers. We're infatuated with our Uber driver friends.
Speaker 2:Hey. They keep us out of trouble in negative places.
Speaker 3:Or delivery. That's important. Now, you know, food delivery might be I guess it's gonna depend. If you're an independent food delivery person, that's one thing. I mean, if you if you, deliver pizzas, commuting is not deductible.
Speaker 3:So let's say you have a little office in your home and you you work at a a pizza chain and you drive there and then start delivering from there, that would not be a home office. But, but, yeah, I mean, especially after the pandemic, we see so many home offices being used. And and so, yeah, I mean, there are some special rules for corporations and day care providers. But at this point, we really wanna talk to the masses. So remember, regular and exclusive use, principal place of business.
Speaker 2:So before I ask you but I'll tell you what I'm gonna ask you. So what are a couple myths we could somewhat debunk here? So one of them and I know the answer to most of these, but I'll ask the first one. Say I'm a w two employee. Do I also get a home office deduction?
Speaker 3:Well, our CPA friends out there absolutely love that w two employee term because it's ultimately this you can't be a w two anything else. Mhmm. So I'm sorry to jab at you.
Speaker 2:I take it. I'll let
Speaker 3:you say you're an employee. Okay? And, also, for those out there, if you tell me you're a ten ninety nine employee, I wanna virtually slap you because you can that that's you have to be a ten ninety nine contractor. You can't be that. But, anyway Mhmm.
Speaker 3:Let me get off you know? Now CPAs out there and tax preparers would get a little frazzled.
Speaker 2:I can see. You're getting a little red in the face.
Speaker 3:I haven't been this upset since the single member LLC episode.
Speaker 2:Well, yeah. Yeah. I'm now I'm scared. Now I gotta go hide.
Speaker 3:But But, you know, great question. So in in general, an employee of of a company is not entitled to a home office deduction anymore under the Tax Cuts and Jobs Act of 2017 because you don't have an you don't have what's called a, unreimbursed employee business expense. Now if you own a corporation or or you're an s corporation and you have a home office, there are ways that and this special rules apply, like, are gonna go beyond this this podcast, but there are ways to take the home office deduction by having an accountable plan or potentially what's called a section one thirty nine plan. So there are different different ways that someone could be reimbursed for their offices, either an employee fringe benefit.
Speaker 2:Which circles right at the entity selection, which we won't talk about that now. It's all another thing. So so we answered that. So what what's another myth Sure. A myth.
Speaker 2:That that we think or not that we think that you've seen in twenty years. You've been doing this a lot longer than most people. You you old man. Most people.
Speaker 3:You haven't seen our profession. You just we need young people in our profession. No. I'm just saying.
Speaker 2:That is
Speaker 3:true. So, biggest what I feel is the biggest myth is that a home office deduction is going to cause an IRS audit. That really bothers me and a lot of other practitioners because what you have to understand, and we'll talk about this in in other episodes when we talk about automobile and truck deduction, is that commuting miles are not deductible. Okay? So in let so if you work out of your home and you don't take the home office deduction, then you basically have a bunch of commuting miles.
Speaker 3:So you you if you you generally work from the home, you need to take the home office deduction. I have other people that another myth is that, well, I'm worried about I'm gonna have to pay taxes when I sell my house. Now there are some concepts called depreciation recapture where you could potentially bring income back on your tax return when you sell your house. It's but it's such a small amount. Or if you're that worried about it, take take the simplified home office deduction, which is a great segue into the two methods of home office deduction that people have to be aware of.
Speaker 2:Excellent. And I mean, I know we, you know, we can give endless examples of people who do take advantage of this. You know, some obviously maybe not to its fullest extent. Some unfortunately, maybe way beyond what they should, which is a whole another another animal on its own. But a lot of lot of examples, real estate agents, freelancers is one, you know, working from home.
Speaker 2:Again, seeing some very creative office spaces is great. But what what's some maybe, I would say, nonconforming? But, like, you mentioned an Uber driver. Right? So that Uber driver is likely at home doing some form of paperwork, unless they're just on their phone.
Speaker 2:I mean, it's not like you have to have this grand office and, you know, watching a stock ticker all day in your office to to classify as that. But, I mean, there there's almost endless endless professions out there, we should say.
Speaker 3:Exactly. Well, let me finish the thought just so everyone's aware. When you take the home office deduction, you have two two options. You could take the simplified method, which is a $5 per square foot deduction up to $1,500 or actual expense where you're taking a portion of your indirect and direct expenses. Let me circle back to those myths, and, I think we're gonna create some additional content.
Speaker 3:One myth is that you have to own a home to take the home office deduction. You can be a renter and take the home office deduction. You just take a percentage of that rent based on the a lot of times, renters get a better bigger home office deduction because a lot of times they're renting a smaller space, and the home office makes up a bigger percentage of the home, thus creating a bigger deduction. So the there are some rare circumstances. I know we're gonna you know, we'll we'll we'll talk about day care specifically in another episode, but we have we have clients that very, very frequently, we have a client that might have some land, and they have a home on that land, and then they have a pole barn where they have a shop there.
Speaker 3:They might have they might repair vehicles. They might, have a small small engine shop. So there's some unique situations where when we say home office, it's kinda misleading because you don't have to have an office to have a home office deduction. Right? You could have a shop.
Speaker 3:Mhmm. You could have, like, a printing press. You could you know, we have clients that have have, retail they make retail shirts and print and, and they do that all out of the out of their either their home or a separate structure.
Speaker 2:So I so I'll bring this one up again. I I feel like I remember asking yours or somebody else this question. I mean, it was a long time ago, and we've known each other twenty plus years. So it's some point in those twenty years, I think I've asked you this. So what if and and I know this this could go down a a little bit of a different path, which I like to do to you anyway, so we'll keep it in.
Speaker 2:But what's that misconception about, oh, well, I can only take a deduction as long as, say, my home is not paid for in full, or, oh, my I have expensive or say you're paying for utilities. How do I fix it? We'll just say figuratively, oh, I have $500 a month in expenses. Say you have a say you have Internet. We'll leave cable out of it because you shouldn't go watch cable while you're working anyways, especially if you're a a contract worker.
Speaker 2:So say you have 505 hundred dollars monthly collective utilities for your entire home. It's paid off, so you have no mortgage. Say say you live very modestly. How does that yes or no. And I'm smiling because I know this phone because you just talked about it.
Speaker 2:But how does that impact That's really cool. Home office deduction?
Speaker 3:Well, in general, you're gonna file a form eighty eight twenty nine when you claim the home office deduction. And we'll we're gonna put a link to the 8829. We're also gonna put a link to publication May in the show notes. You have the option to take the actual or some rather simplified or actual expense. So in that case, John, let's say you have a home that's 2,000 square feet.
Speaker 3:Let's say you have a 200 square foot nice big bedroom that you utilize for your home office, so 10% of your home is the home office. Any indirect expenses such as utilities will you will take 10% of that, and you'll deduct that on your tax return. That's the indirect those are indirect expenses. The mortgage interest is an indirect expense. The depreciation deduction so even if you have a home that is paid off, you could still take actually, you need to take the depreciation deduction if you're taking the actual home office deduction, another myth.
Speaker 3:But you have to because that's gonna get added back to your income if you sell the house anyway. But the depreciation deduction, you might also have direct expenses. So our friend that might have a pole barn that has separately metered utilities to the pole barn will and they use that pole barn a % for business, which is a very common fact pattern. They get a % of that utility because it's a direct expense. So you have indirect and a direct expenses.
Speaker 3:Now if you're not good at record keeping, you probably just wanna take the simplified method.
Speaker 2:Did you look at me when you just said that?
Speaker 3:Of course. Thank goodness your wife is.
Speaker 2:So so, actually, so here's a question for you too. So say and, of course, I'm not asking with that of personal interest. I never would. I don't wanna, you know, bring my wife into this mix. So say for say for example, somebody was building a barn, building a structure, building a detached garage, some form of structure on their primary residence, but that structure was going to have exclusive use.
Speaker 3:Okay.
Speaker 2:Would you have to have dedicated utilities to that, or do you just really fall into breaking down, you know, based off of the square footage?
Speaker 3:You do not have to have separate utilities to take the home office deduction.
Speaker 2:I hope my wife heard that because it that makes her proud. Brag. Anyways oh, no. Sorry. I admit I wouldn't bring her in this.
Speaker 3:Alright. Perfect. But but in in in one other myth that I wanna bring up and we're gonna we're gonna talk about, talked about people that are employees, not w two employees, redundant man over there. Inflection with that. Right.
Speaker 3:But if you are a partner or a member partner in a partnership or a member of an LLC, you might be entitled to the home office deduction. Yeah. And you would take that deduction as an UPE, unreimbursed partner expense, to offset that k one income. So let me give you an example. John and I start a podcast.
Speaker 3:Figured it. Exactly. We're the we we started LLC, not necessarily required to do it, but we started LLC for the podcast. We do the podcast. We have an ad revenue and and a bunch of some expenses.
Speaker 3:But in our operating agreement in the LLC, because John and I live in different states and we don't let's say we don't have an office, we're required to maintain our own home office to record the podcast. So in that case, if the podcasting was your only let's say it was your primary job and you had regular exclusive use of of portion of your home, you could take the home office deduction against k one income. So you don't have to be self employed necessarily or the only owner of a business to take the home office deduction.
Speaker 2:So I would put this challenge out there to everybody. And, of course, we can see what you're if you're being truthful. Raise your hand if you knew exactly and everything that Chris has mentioned to us in the past couple minutes. I would love to raise my hand, but I can't, so there's me being honest. And that, I think, really dives into or or kind of slowly creeps into it.
Speaker 2:How I wouldn't say complex. I don't like the word complex, but there's a lot to it. And I think that being said, there's a huge opportunity to take more advantage of it or maximize that deduction. But there's also an opportunity to just enter a number into a box, you know, in in doing your tax prep and potentially be way off in a positive or negative manner.
Speaker 3:Correct. And and we welcome people to join our private Facebook page, defeating taxes. That's defeating taxes. Jump in for we have a lot of people jumping in, and we've talked about home office quite a bit. My my best advice would be is if you think you are eligible for home office, make sure you get into our Facebook group at a minimum, and make sure you connect with one of our teaching tax law black belts, which are our tax professionals.
Speaker 3:At a minimum, take the simplified home office deduction. Take your $5 a month $5 a square foot, which also enables you to take any type of mileage or or auto and truck deduction because your commute's from your drive from your home to your driveway. If you think that your situation is a little more complicated and you think you could benefit, then look at the actual expense home office deduction.
Speaker 2:And before we actually close out, this is gonna be a very cheesy lead in to, again, thanking our our supporter sponsor on this. If you are looking for a property with a huge home home office opportunity Alright, dad joke. I'm done. Chris Chris, who who brought us here again today? Who who is supporting us and our ridiculous personalities and contact?
Speaker 3:Before I say that, I want I'm gonna mention one more thing.
Speaker 2:Oh, boy.
Speaker 3:No. That's alright. We we luckily run into very few audits, in person audits. I've had two in person audits in my twenty year career where the auditor wanted to go to the property of the taxpayer and review their home office. Okay?
Speaker 2:This is it's
Speaker 3:a real story.
Speaker 2:I didn't even know this one, so now I'm intrigued.
Speaker 3:So first step and, you know, our buddy, Andrew Pulos, with Chuck Lloyd. We're gonna get him on for another, war stories. First step, get a power of attorney, of course. Second step, evacuate the homeowners. So they are gone.
Speaker 3:I met that IRS agent at the home both times. They looked at the home office. They said, yeah. This guy's got a home office. I'm like, of course, they do.
Speaker 3:But we wouldn't have deducted it if they didn't. And I just think the IRS wanted this is wanted someone from the IRS wanted to get out of the office, and they got and it was a lot.
Speaker 2:Can we ask what may have triggered that, or is it just a really random selection problem?
Speaker 3:Actually, I did find out. So interestingly enough, the IRS agent told me that when the what triggered it was that the home office deduction was over 20% of the home square footage. Oh. And that's just a parameter. When you go above 15%, it increases your examination risk.
Speaker 3:But here's the thing. It was over 20%, and they didn't just they allowed the entire deduction. So if you legitimately have a home office that's 25, 30 percent I mean, we have especially in the Nashville area, we have musicians that they might buy a a three bedroom property and take the master bedroom and make it into a a studio devoted to their music. And it could be over 20% of the property really easily. So never be afraid to take a deduction if you're entitled to it.
Speaker 3:That's it. That's all I have in that because I know we're
Speaker 2:Well, now I'm, like, super intrigued with this. So, yeah, thank thank you for sharing the example. I mean, I thought I knew everything about you, but I've never heard that story. So, yes, let let's thank who who supported us.
Speaker 3:Absolutely.
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Speaker 3:Thank you very much, The Mortgage Shop. Brenda and the crew there doing amazing job. Again, jump into the defeating taxes private Facebook page. Thank you for listening. Please, five star review.
Speaker 3:So rate, review, subscribe to this podcast. We love sharing our knowledge here at Teaching Tax Flow with you, and we hope that you got some takeaways from this.
Speaker 2:Awesome. Thank you as always, Chris. Thank you everybody for joining us. We, as Chris mentioned, we're gonna drip out, in some of the show notes, a couple links, to some resources as well as, while we were chatting here, I jotted down an idea which we will likely post on the defeating tax flow or I'm sorry, the defeating taxes and teaching tax flow, Facebook group and page. And we will see you next week as always.
