For most Real Estate Agents, the home office is a relatively small, but significant deduction. Its primary benefit is not the size of the write-off, but what else it makes deductible – additional auto use. Our Real Estate Agent: Tax-Cut Library covers the home office and auto relationship extensively. Our article, What Auto Use is Deductible, covers the basics of maximizing the auto deduction with a qualified home office. This article will discuss the IRS requirements for having a deductible home office.
IRS Definition of a Qualified Home Office
Several criteria must be met to have a home office that is deductible according to IRS rules. The area must be used 1) Regularly for business, 2) Exclusively for business, as 3) Your principal place of business. To better understand these requirements, let’s take a closer look at each.
- Regular Business Use: The home office must be used regularly for business over the tax-year. Regular business use, like many aspects of the tax code, is a somewhat grey - there is no black and white definition of what constitutes regular business use. The best the IRS can do is say that regular use is consistent - used in an ongoing manner. As vague as this explanation is, however, use as little as once per week or several times per month will most likely qualify as regular business use.
- Exclusive Business Use: The area claimed as a home office must beused ONLY for business. This requirement disallows many home office deductions upon audit. Does the home office have kid’s toys in it? Is the desk used for homework or paying household bills? Does it contain a couch with a pull-out bed used by the in-laws when they visit? If the answer is “yes” to any of these questions, the area does not qualify as a deductible home office.
Only means ONLY – no use other than business. The rigidity of Exclusive Use rule, however, does not disallow part of a room from qualifying as a home office. If, for example, you have a desk and a filing cabinet in your guest bedroom that are used exclusively for business, the portion of the room that includes the desk and filing cabinet will qualify as a home office. The fact that guests also use the bedroom will not disallow the home office deduction.
When part of a room is used for business, partitioning the personal-use and business-use area is not necessary. Take care, however, to ensure the business and personal use areas do not bleed into one another. Mixing personal records with business records in the business filing cabinet, children using the business computer for homework, or guests using the business desk while visiting will all disqualify the home office.
Principal Place of Business: The final requirement of a qualified home office is that it be your principal place of business. There are three ways to meet this requirement. 1) The office is used to meet with clients regularly, 2) It is a separate structure ONLY used for business, or 3) The home office is used to conduct administrative duties, and the owner has no other place to perform these duties.
Most real estate agents do not have an area in their home that is used regularly and exclusively to meet with clients. Even less have a separate structure devoted entirely to business. The majority of agents, however, will meet the administrative duties requirement if they use the office to perform these duties and have no other location to do so.
Administrative duties include a wide variety of activities such as scheduling appointments, paying business bills, conducting research, creating promotions and advertising, gathering leads, and keeping records. It can also include consulting with outside vendors who perform services such as bookkeeping or website maintenance. If the home office is used to perform these functions, it will qualify as a principal place of business.
Substantiating Your Home Office
When it comes to taxes, it’s not the IRS’s job to prove you are not entitled to a deduction. It’s the taxpayer’s responsibility to show they are entitled to every deduction claimed on your tax return. You have the burden of proof, not the IRS. No evidence, no deduction.
The home office deduction is different from deductions easily substantiated with a receipt. The use of rooms and space in a home can change often. You may not even live in the same town when the IRS requests proof of your home office! How can you prove that you had a qualifying home office years after filing your tax return? The IRS (as forced by the Tax Court on many occasions) understands that this may be a daunting task and will, generally, not question a home office deduction if it is; 1) Reasonable, 2) You can show it was your principal place of business, and 3) There is some evidence of its regular and exclusive business use.
Reasonable: Space claimed as a home office is reasonable when it reflects the needs of your business and household. In other words, when it passes the smell test. Deducting a whole bedroom as a home office may not pass muster for an agent who has a spouse, six children, and lives in a three-bedroom home. On the other hand, the same agent may find that a small area in the family room of the three-bedroom home quickly gains IRS acceptance as reasonable.
Principal Place of Business: To substantiate your deduction, you must also show that your home office was your principal place of business. The following measures will help prove this requirement:
- Use your home address on all licenses and official documents.
- Have business mail delivered to your home.
- If it’s not a security issue, use your home address on business cards, letterhead, and appropriate marketing items.
- A statement in your agent agreement stating that agents are expected to manage the business affairs on their own time and at their own expense.
- Showing you have no other location to perform administrative duties.
Regular & Exclusive Use: Here are a few tips to help show the home office was used regularly and exclusively for business:
- Create a log showing hours or days worked in the office (nothing too elaborate – notes in a binder/calendar will suffice).
- If your office has a desktop or laptop computer, make sure you save business files on it and that the desktop screen is clear of games and nonbusiness applications.
- If you have a phone landline, put the number in your business name and keep a phone in the office.(Note: the 1st landline to your office may not be deductible).
- Take a picture of the office.Better yet, a photo of you using the office exclusively for business.Make sure you do this if you ever move or change the use of the home office area.
- If you meet clients at your home office, document your meetings.
- Carbon Copy your email address on all sent business emails and save those you receive.
- If you use your smartphone for emails and faxes, have them sync to your home office computer.
- Keep the area clear of personal items – don’t store family photo albums in the desk drawer or store folded laundry on top of your filing cabinet!
If these steps seem cumbersome - remember, it’s your responsibility to prove you are entitled to the home office deduction – no proof, no deduction. If the IRS denies your home office deduction, you can expect to see other deductions - such as auto expense - reduced as well.
Take Away: The Home Office Deduction is an essential deduction for real estate agents that helps them maximize their business auto deduction. It’s also a deduction most agents qualify to take. Care, however, must be taken to ensure your office meets the regular and exclusive use tests and is your principal place of business. You must also be prepared to substantiate the deduction years after you file your tax return.
Summary and Invite: We hope this article helped you to understand the requirements of having and deducting a home office. If you’d like to learn more about cutting your most significant expense, TAXES, check out our Real Estate Agent Tax Cut Library. The Real Estate Agent Tax Cut Library includes over eight hours of video broken into twenty-nine searchable volumes and covers every possible deduction a Real Estate Agent can take on their tax return. Our Broker Version will help your entire agency cut their taxes! We also invite you to browse our courses.