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Saving taxes with the lost home office deduction
The IRS encourages small business owners to explore the guidelines surrounding this expense deduction and the options available.
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Although working from home is more and more common, merely having a space within the home used as an office does not mean an automatic tax deduction for the expenses of operating it.
Employees, even employees of their own optometry practice, have long treated home office expenses as a miscellaneous itemized deduction. Unfortunately, thanks to the Tax Cuts and Jobs Act (TCJA), employees who work from home are no longer able to deduct their home office expenses. Of course, anyone who runs a practice or business from home or is considered to be self-employed and using part of their home for business purposes may still deduct home office expenses.
For those self-employed professionals and practices still able to take advantage of the home office expense deduction, qualifying is relatively straightforward. In general, part of the house must be used:
- exclusively and regularly as the principal place of business;
- exclusively and regularly as a place where patients, clients or customers are met in the normal course of business;
- on a regular basis for certain storage; and
- in the case of a separate structure that is not attached to the home, in connection with the optometry practice or business.
Unfortunately, while appearing relatively easy to meet, the IRS strictly interprets many of these requirements. First, as mentioned, the home office expense deduction applies only to a business or professional practice. Managing investments is not a trade or business in the eyes of the IRS.
Exclusive use
Using the space labeled as a home office exclusively for business purposes is, as mentioned, a basic requirement. Space being used as the principal place of business for the optometry practice and used “regularly and exclusively” is defined as follows:
Regular use: A specific area in the home used for business purposes on a regular basis. Incidental or occasional use is not regular use.
Exclusive use: A specific area in the home used only for business. While it is not necessary for the space to be physically partitioned off, the requirements will not be met if the area is used both for business and for personal purposes. A home office that doubles as a guest bedroom is clearly not used exclusively for business purposes.
In addition to regular and exclusive business use, the home office must be the principal place of the practice or business.
Principal place of business
The principal place of business requirement is fairly broad and does not mean “only.” In fact, the home office will qualify as the principal place of business if it is used exclusively for administrative or management activities – and if there is no other fixed location where substantial administrative or management activities of the optometry practice are conducted.
Other locations
Of course, if there is more than one location, the relative importance of the activities performed at each place must be considered along with the amount of time spent at each site.
Examples of activities the IRS and the courts consider as administrative or managerial in nature include:
- billing patients, clients or customers;
- maintaining books and records;
- ordering supplies;
- setting up appointments; and
- forwarding orders or writing reports.
More rules
Regular and exclusive use as the principal place of business for the optometry practice is not the only criteria. Among other factors that enter into the equation are:
Meetings. If the home office is the principal place of business for the optometry practice, the home office expense deduction remains as a viable option. As mentioned, physically meeting with patients, clients and customers frequently suffices with an IRS auditor. Naturally, the use of the home office must be substantial and integral to the optometry practice.
Storage. Do not forget that the home office expense deduction can be claimed for a storage area in the home – or in a separate, free-standing garage or barn that is used exclusively and regularly for the optometry practice.
Separate structures. The separate structure does not have to be the principal place of business or even a place where the optometrist meets patients, clients or customers in order to qualify for the home office expense deduction. Unfortunately, using a separate structure might mean missing out on the gain that can be sheltered from taxes when the residence is sold.
Home sale complexities
When a principal residence is sold, capital gain of up to $250,000 ($500,000 for married couples filing jointly) can be excluded or ignored for tax purposes. In order to qualify for this exclusion however, an ownership test must be met.
An individual or couple is eligible for the partial exclusion of gain on the home sale if the home has been owned and used as the main home for at least 2 years out of the 5 years prior to the date of sale. Of course, if the property was used partly as a home and partly for business gain it does not have to be allocated between the home part and the business part.
Naturally, no part of the gain relating to depreciation allowed or allowable (after May 6, 1997) as a home office expense can qualify for exclusion, even where the home sale itself qualifies for the exclusion. The depreciation recapture (so-called Section 1250 gain) is taxed as ordinary income, but at a rate that is no more than 25%.
Deductions for storage space are allowed when the home is the only fixed location of the optometric practice. The rules are different if a separate structure is used for business purposes. Exclusive use is not required to qualify for the deduction.
However, gain resulting from the sale of a separate structure cannot be excluded because of the requirement that the property must have been owned and lived in for at least 2 years during the 5-year period ending on the date of sale.
If the business use was in a separate structure and the use test was met, an allocation of the gain on the sale must be made. Any resulting gain must be reported as well as any recapture of depreciation allowable or taken.
Strategy options
Every optometric professional thinking of claiming the home office expense deduction has two options. The first option for calculating the home office expense deduction is the “regular” method.
The regular method requires computing the business use by dividing the expenses of operating the home between personal and business use. Direct business expenses are, obviously, fully deductible, with the percentage of the home’s floor space used for business applied to indirect total expenses.
Although expenses for the nonbusiness portion of the home are not deductibl, expenses such as the business portion of real estate taxes, mortgage interest, rent, casualty losses, insurance, depreciation, maintenance and repairs, are deductible home office expenses.
The increasing number of optometrists working at home or operating their practice from home now have the option of a new “safe harbor” deduction for home office expenses. The so-called “safe harbor” or “simplified” method reduces the paperwork and recordkeeping burden.
The simplified method uses a flat rate of $5 per square foot for business use of the home. There is a maximum allowable deduction based on up to 300 square feet that places a ceiling on the total amount deductible under the safe harbor, “simplified” method at $1,500 annually.
Choosing the simplified method merely requires completing a short worksheet and entering the result on the annual tax return. With either method, self-employed optometrists file Schedule C, Profit or Loss from Businesses, and compute this deduction on Form 8829, Expenses for Business Use of Your Home.
Whether space in the home is used as a home office for an optometry practice that is based there, or if the home office is used to supplement the practice’s primary place of business, a tax deduction may be available. Regardless of the method used to compute the home office expense deduction, business expenses in excess of the practice’s gross income are not deductible.
The tax-saving home office deduction
Obviously, the tax deduction for maintaining a home office and the related expenses provides a valuable tax-saving opportunity for self-employed optometry professionals and optometry practice principals who work from home. While the TCJA eliminated many deductions formerly allowed as miscellaneous itemized deductions on personal income tax returns, the home office expense deduction continues to apply to the optometry practice.
The IRS continues to encourage all small business owners to explore the guidelines surrounding the home office expense deduction and the options available. They are reminding everyone that the home office expense deduction applies only to self-employed optometrists and optometry practices, with the option of deducting proportionate operating costs or using the new simplified method.
Fortunately, a legion of professional advisors stands ready to help every self-employed optometrist and optometry practice as they attempt to navigate the complex and often confusing rules surrounding the home office expense deduction – and the tax saving possibilities.
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- Mark E. Battersby has been reporting on news and developments in the tax and financial arenas for more than 25 years. He can be reached at MEBatt12@Earthlink.net.
Disclosure: Battersby has no relevant financial disclosures.