Maintaining a home office for your business can yield a benefit at tax time if you’re able to claim a deduction for your expenses. The IRS lays out the rules for deducting home office costs in Publication 587. There’s a common myth about this deduction triggering an audit. But that shouldn’t stop you from claiming it if you’re eligible. Here’s more on how this deduction works and what it covers.
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Home Office Tax Deduction Defined
Generally, the home office deduction is a way to offset the costs of paying for a home office by reducing your taxable income for the year. According to the IRS, the deduction applies to the business use of a home and can be claimed whether you rent or own the property. There are two specific criteria you need to meet to be able to claim the deduction.
1. Regular and exclusive use
This IRS rule specifies that for home office expenses to be deductible, you must regularly and exclusively use part of your home for doing business. That means you can’t claim the deduction if you only use the home for business occasionally or incidentally.
There are two exceptions. First, this rule doesn’t apply if you run a daycare service from your home. You do, however, have to be licensed in your state to do business in your home as a daycare. The second exception is if you use part of your home to store product samples or inventory. This only applies, however, if you exclusively do business from your home.
In that scenario, the IRS would still let you claim the deduction as long as the administrative tasks involved in running your business happen at home. So if you’re a traveling salesperson, for instance, but you do all of your accounting and paperwork in the home office, you’d be covered.
2. Principal place of business
The second part of qualifying for the deduction has to do with proving that your home is your principal place of business. That doesn’t mean you can only do business at home but it does mean that the majority of business activities must take place there. If you take the occasional lunch meeting with a client or deliver products to customers in person, for example, that wouldn’t count against you.
This rule also doesn’t require you to do business inside the home. You could still claim the deduction for home office expenses even if your office is technically in the garage or in a shed on your property.
Which Home Office Expenses Are Deductible?
The IRS allows a broad scope of deductible expenses for a home office. Those include both direct and indirect costs.
Direct expenses include costs related to the specific area of your home you use for business. So if you plan to build an addition on to the home to use exclusively for business, you may be able to deduct some or all of those costs. The same is true if you install a phone or internet line just for business use in one part of your home.
Indirect expenses are costs you pay to maintain the home itself. So, things like utilities, internet service, repairs, depreciation or homeowner’s insurance could fall into that category. You could also put a home security system in this category.
Generally, for an expense to be deductible it has to be related to your home office space or the home itself. Understanding which expenses you can deduct can help you decide which set of rules to follow when estimating what the deduction is worth.
Home Office Tax Deduction Calculated
The IRS gives business owners and self-employed individuals who maintain a home office two ways to calculate what the deduction is worth. You can use either the regular method or the simplified option.
The regular method requires you to calculate your deduction based on the actual expenses associated with your home office. So again, that could include things like mortgage interest, insurance, utilities, depreciation and general maintenance.
When you use this method, your deduction is based on the percentage of your home that’s actually used for business. Here’s an example. Assume you have a 2,500 square foot home and your home office is 150 square feet. You also use 225 square feet in the basement for storing inventory related to your business. Altogether, your office space represents 15% of your home’s square footage.
Now, assume that your indirect expenses for the year to maintain your home office total $10,000. The deductible part of that would be $1,500 ($10,000 x 15%). But, you also spend $2,000 on direct expenses related to your home office. You could add that to the $1,500 for a total deduction of $3,000.
This method requires you to keep good records of all your home office and home-related expenses throughout the year. The simplified option, on the other hand, offers an easier approach to figuring up your deduction.
There’s a three-step process involved if you choose to take the simplified option for claiming the home office write-off.
First, determine the total area of your home office space. The IRS maxes the limit for allowable area out at 300 square feet. Once you have this number, multiply it by $5.
Then, subtract business expenses unrelated to the use of your home from gross income related to the home’s business use. If the expenses outweigh the gross income generated by business use of the property, you can’t take a deduction.
If the gross income number is higher, compare that to the amount you got in step one by multiplying your allowable business area by $5. Whichever of the two numbers is smaller is the amount you can claim for the home office deduction using the simplified method. Using the $5 guideline, the maximum amount you could deduct would be $1,500.
Which method you decide to use depends on how much of your home is used for business. Your business expenses and gross income matter as well. Your recordkeeping also factors in. If you don’t have records to support the regular method, choose the simplified option.
Claiming the home office deduction can be valuable if you’re hoping to minimize your business’s tax liability. Using both the regular method and the simplified option can help you decide which holds greater tax benefits.
Keep in mind that claiming the deduction in one year doesn’t automatically make you eligible the next. You’ll still need to meet the regular and exclusive use and principal place of business criteria each year.
Business Tax Tips
- Unsure how home office expenses or taxes may affect your bottom line? You may want to consider speaking to a financial advisor. Finding a financial advisor doesn’t have to be hard. SmartAsset’s free tool matches you with up to three vetted financial advisors who serve your area, and you can interview your advisor matches at no cost to decide which one is right for you. If you’re ready to find an advisor who can help you achieve your financial goals, get started now.
- Home office expenses aren’t the only thing you can deduct for your business. The Tax Cuts and Jobs Act eliminated certain deductions for business. It also introduced some new tax rules you could take advantage of, such as the 20% pass-through deduction. If you typically do your own business taxes, consider talking to an accountant or professional tax preparer to look for any missed opportunities to cut your tax bill.
- If taking the home office deduction or other business expense deductions allows you to put money back in your pocket, consider how you can put it to work. For example, you may want to open a self-employed retirement plan. Consider a SEP IRA or a solo 401(k) if you haven’t done so yet.
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