The Internal Revenue Code allows taxpayers to take a deduction for the business use of their home. This is a valuable and underused deduction, but yet it is a easy target for the IRS because it is also frequently misused. There are a few different ways that physicians and their families may be able to legitimately use the deduction, but first we need to set up the requirements:
- Exclusive business use. The part of your house that you are claiming must be exclusively used for your business. This means that charting on the dining room table doesn’t result in the whole dining room being your office, since you also likely eat dinner there as well. It needs to pass the smell test if an IRS agent were to go to your house and look at the alleged exclusively used business space. It does not have to be separately partitioned or take up a whole room, but rather only claim the square footage area that you actually use.
- Regular business use. With some exceptions that I will mention later, the claimed area must be regularly used for business. Again, this will also be fairly logical based on your circumstances.
- Trade or business use. You cannot take a home office deduction for couponing or any other hobbies, even if they have a for-profit motive. It has to be for an actual business, best supported by a Schedule C, 1120 or other business tax return.
- Principal place of business. Although there are some important exceptions to this rule, generally the home office must be the principal place of business. Physicians who work 60 hours a week at their medical office generally cannot claim their home-office as their principal place of business. That said, there is an exception if the home office is the only location where administrative and management duties are conducted and the home office is exclusively and regularly used for such purposes.
With that framework, here are some circumstances in which a physician may be able to take a home-office deduction.
- Physicians who are performing locums work or are traditional independent contractors. If you work in multiple locations as an independent contractor, then your home office is usually where the administrative and management duties are performed. The IRS even gives an example of an anesthesiologist who works at three different locations, and has access to office space at one of those locations but instead chooses to use his home as his office for administrative and management duties. This could even apply to a physician who has a full-time job but then has a separate business for her locums work, in that if the locums work is a separate business, then a home office deduction may be available for that work.
- Physicians who meet with patients at their home. This is fairly uncommon, but physicians who meet with patients in their home as part of the normal course of their business can qualify for the home office deduction, even if they have another office location as well, so long as the business use of the home is substantial and integral to the conduct of their business.
- Separate structures have lower standards. A physician with a detached garage, workshop, barn or other structure can use it as a home office for charting or other duties even if it is not the principal place of business and without meeting patients there, so long as that is the exclusive and regular use of that space.
- Spouses have jobs too. Just make sure that the spouse’s home-based business fits the above requirements and isn’t a hobby. Selling a couple of artworks a year may not cause the home studio to be a home-office, but selling many pieces a year with some marketing effort and having customers visit the studio would greatly increase the odds of the space being deductible.
The actual deduction for a home office can be broken down into two categories. The first includes all of the direct office expenses, such as repairs to the area used for business, new paint or carpet (furnishings are separate from the home office deduction). Those types of expenses are deductible in full. The second category includes all indirect expenses for upkeep of your entire home, such as taxes, mortgage interest, insurance and utilities. Those must be deducted based on the percentage your home that is used for business. If you have a 200 sf office in a 4,000 sf house, then you can deduct 5% of those expenses. For your taxes and mortgage interest, if you are able to deduct those as part of itemizing deductions, then make sure not to double count them.
You can also take a depreciation deduction for your home, which is not otherwise available for a personal residence. It is a fairly complicated calculation, but it can add up to be a decent deduction. The problem with the depreciation deduction is that when you sell the house, you will have to recapture that prior depreciation in the form of income to the extent you have gains on the sale of the home. Generally, the tax benefit from the depreciation deduction outweighs the later gain on the sale, especially when you factor the value of getting the benefit now but paying the tax later.
Importantly, in the past few years a “simplified method” for computing the deduction has been implemented. It does not change the above requirements for the deduction, but instead of calculating depreciation and the pro-rata home expenses as described above, you just take a deduction of $5 per square foot. This method should decrease your audit risk, and it does not result in depreciation recapture on selling the home, although it is limited to 300 square feet each year. As a result, unless your traditional home office deduction is much greater than your simplified home office deduction, the latter is the safer way to go.
As with all tax advice, please read the disclaimer and consult with your attorney or accountant before taking action.