What Are the Risks of a Home Office Deduction?

It can seem like a no-brainer to claim the home office deduction if you match the qualifications.

But hold on! Even though this deduction can significantly improve your bottom line at tax time, it isn’t always in your best interest. Before claiming this deduction, there are several factors you need to take into account. You should make sure you are eligible and be familiar with the various calculating techniques.

Depending on the size of your home office and the value of your home, you may be able to save a lot of money on taxes. Just by using the home office deduction.

It makes sense to lower your overall tax burden. When deciding whether to claim a deduction on your income taxes, there are a few considerations to bear in mind.

Who Can Take Advantage of the Home Office Deduction?

Whether you are a self-employed person or work for a company affects the deduction. Working from home is not the only factor.

If you are an employee, you are not qualified for the home office deduction. Millions of people were forced to return to their homes nationwide because of COVID-19. Many people weren’t sure if they could claim the home office deduction. Employees are not eligible, to put it simply.

However, if you work for a firm and run a side business, you are a small business owner as well! This means that as long as the area you use to conduct business is located within your house, you are qualified for a home office deduction.

If you sell goods online, for instance, the area you use to keep inventory or produce the goods you sell can be eligible for the home office deduction. If you meet all the other requirements, of course.

Will Your Deduction Produce a Profit or Loss?

When thinking about the home office deduction, it’s also crucial to examine whether you’ll make a profit or a loss after taking it into account.

You can carry forward your portion of the actual business home office expenditures if your company experiences a loss for the year. This implies that you can carry the loss forward and use it in the following year when you make a profit.

You might carry over your losses into Year Two when you start to turn a profit, for instance, if you had $1,000 in home office expenses that you couldn’t cover in Year One because you weren’t profitable. Therefore, nothing is lost; simply wait till you turn a profit.

The Prospect of an IRS Inspection

The home office deduction has been around for a while—since 1959, to be precise. Due to a purportedly heightened danger of an IRS audit, many people have grown afraid of the home office deduction over the years.

While there is no certainty that you will get an audit notification if you use this deduction, there may be some truth to the idea that it would make one more likely. The Discriminant Inventory Function, the IRS’s method for detecting and preventing fraud, is involved in all of this (DIF).

Tax returns are grouped by profession in the DIF, which then examines anomalies to spot red flags. Let’s imagine you sell goods on the internet and set aside 20% of your earnings for travel. However, the average eCommerce seller only sets aside 5% of their income for travel, according to the DIF. Your return will be flagged as a result, increasing the likelihood of an audit.

Similar to this, the DIF will examine who claims the home office deduction and compare that to other workers in that sector. If you claim the home office deduction and are a freelance writer. That probably complies with industry standards for freelance writing. However, the likelihood that the DIF may flag your return greatly increases if you are the only freelance bartender taking the home office deduction.

You Must Consider the Long-Term Potential

Consider the sale of a house as an example. When you sell the home where your home office is located after having claimed a home office deduction, it can have an impact on your capital gains taxes.

How long you’ve been claiming that home office and how you claim it could have a significant impact on the sale price of your home. The amount you have claimed for depreciation on your home office could lower the amount of the capital gains tax exclusion. That is permitted from the sale of your primary property.

This does not apply if you take the simplified deduction. The deduction from the simplified technique is lower. But since there is no spending tracking involved, keeping records is simple. The simplified approach has a 300 square foot maximum and a current price of $5 per square foot.

Although the true technique will offer you a significantly greater deduction for the vast majority of taxpayers, the simplified method may be simpler to compute. The actual technique, in the majority of cases, provides you with the greatest tax benefit. After accounting for factors like depreciation, mortgage payments, and real estate taxes.

When you sell your house, the IRS does recoup the depreciation you took and taxes you accordingly. They don’t take into account any property appreciation. They just do this for the depreciation you incurred.

The tax rate on capital gains is normally between 15 and 20 percent when they reclaim the depreciation amount. But when you claim a home office deduction, you lower your regular income. which, often, you are paying a tax rate that is substantially greater than 15-20%.

Develop a Plan

If you are eligible, the home office deduction is a fantastic method to reduce your tax liability. Verify that you meet the conditions once more. You should also think about how the home office deduction might affect you in the future.

Contact Your Part Time Accountant right away if you want to put up a tax-saving plan that maximizes your deductible expenses. You can consult one of our professionals to begin developing your long-term, yearly tax plan.