Does the Home Office Deduction Create a Red Flag on Real Estate Agent Tax Returns?

Does the home office deduction create a red flag on Realtor’s tax returns?

Not taking an office in home deduction can cost you hundreds, even thousands of dollars a year in income taxes you shouldn’t be paying.

Yet many agents won’t write-off home office expense because they read somewhere that it increases their audit risk.

Fact is, the IRS created a safe harbor method for taking the home office deduction. So why do financial bloggers claim the deduction is unsafe?  The IRS safe harbor rules help taxpayers properly take the deduction.

Real Estate Agents Often Miss Out on Legitimate Write-offs

Realtors, self-employed individuals and small business owners often miss out on taking legal tax deductions because

(a.) their record-keeping has holes in it

(b.) their tax accountant is too lazy and/or too conservative to take the full deduction

In the case of the Office in Home Deduction, here’s the only questions you should be concerned about

  • Do you qualify for the Home Office Deduction?
  • How can you maximize it so you keep more of your 2019 commissions in your wallet, and send less to the IRS?

Qualifying for the Home Office Deduction is a Two-Step Process

1.) You must use a portion of your home exclusively and regularly for your business.

  • “Exclusively” means it’s a room, or a portion of a room, that is used only for business. For example, a dining room where the table is used 6 days a week as your work desk, but 1 day a week for Sunday dinner, doesn’t meet the ‘exclusivity’ test. On the other hand, if you use a portion of your dining room for business only—for example, a corner of the dining room where a desk and computer are separate from the room’s other uses—that portion would meet the test.
  • “Regularly” means you use that space continually, 12 months a year, and not just during your busiest spring and summer selling months.

2.) The business part of your home must be your principal place of business.

This is the rule that trips up most real estate agents. They think their principal place must be their broker’s office, or wherever they meet with prospects and clients. But Congress has relaxed the rules in this area. Your home office qualifies as your principal place of business—regardless of where you meet customers, and even if your broker provides your business a second location–if both of the following conditions are met:

  • You use it to conduct administrative and managerial activities of your business.
  • You have no other office where you conduct substantial administrative or managerial activities

What this means to you is, if you keep your mileage logs, contact your clients, listen to educational tapes, read business materials, prepare presentations, and so on at home, then you are conducting substantial administrative activities there. You qualify for the Home Office Deduction.

What Expenses can I take for the Home Office Deduction?

There are two types of deductions, direct and indirect.

  • Direct expense is directly related to your home office space . It could include the cost of painting your office walls, or repairing the flooring in your office space. These direct expenses are 100% deductible.
  • Indirect expenses relate to housing costs in general. These include insurance, electricity, maintenance, condo fees, rent, mortgage interest, taxes, security alarm. These all can be deducted based Business Use Percentage (BUP). BUP can be calculated based on square footage, or on number of rooms.

If you use 1 room totally for business, and have 10 rooms in the home, then 10% of your utilities, insurance, etc are deductible. Or use the square footage method; if your office space is 100 square feet, and the total home space is 2,000 square feet, then 100/2,000 = 5% of your insurance, utilities, etc are deductible.

By the way, don’t make the mistake of thinking you have to own the home to take the deduction; just use your rent instead of mortgage interest and real estate taxes.

How Much Can the Home Office Deduction Save You in Taxes?

You can use the actual expense method, or the safe harbor method.

Think for a moment what this means to you. Say you use 1 room exclusively and regularly for your office, and live in a 10 room home, with an average sized mortgage.

Actual Expense Method

Mortgage Interest $14,000

Taxes $2,500

Elec/Gas/Water $2,500

Insurance $1,200

Maintenance $1,000

Pest Control $300

POA/Condo Fees $500

Security Alarm $600

Cleaning Service $2,400

Total $25,000  X 10% =  Total Deduction $2,500

Assuming a 22% tax rate, a $2,500 deduction in indirect expenses alone can save you $550 annually in taxes.

You could be more aggressive, and deduct an additional $2,500 in what tax accountants call depreciation expense (wear and tear on the home). This one move would double your tax savings to $1,000 per year.

But I don’t recommend this for my clients. Adding depreciation in to calculate your home office deduction can cost you big time later on.

Because when the day comes that you sell your home, IRS rules make you ‘recapture’ the depreciation you claimed over the years, and then tax it at a 25% rate.

Safe Harbor Method

Individual taxpayers who elect this method simply multiply the allowable square footage by $5.  In our example, with 100 square feet used exclusively and regularly for business, the deduction would be 100 sq ft x $5 = $500.

You can use the safe harbor method up to a maximum of 300 sq ft, so that maximum safe harbor deduction in that case would be $1,500 per year.

Here’s the bottom line.  A home office deduction can be a tax-deductible gold mine. If you qualify, you should clearly take the deduction. It can put thousands of dollars in your pocket over the next 5 years. That level of tax savings should convince you that taking this legal deduction is well worth the effort.

For more information on steps you can take to maximize your vehicle deduction, contact a trusted tax professional, or contact me if you don’t have one. I’m here to help!

If you find this post helpful, please share it with your friends and fellow Realtors on Facebook, or Twitter, or by emailing it to them. Thank you!