If you’re a business owner with a home office, you may be able to deduct a portion of housing, construction, or maintenance costs come tax time. Many people think that it’s complicated to take advantage of this deduction, or that the Internal Revenue Service views the practice with a high amount of suspicion. Neither of these are true. In fact, it might be easier than you think to claim the home office deduction. Tweet This The key is understanding the guidelines around what constitutes a home office, and how to ascertain a value for the deduction.
Two Requirements to Legally Deduct Your Home Office
Since 1997, there have been two important rules governing the home office deduction:
- The space must be used exclusively and regularly for your business.
- The space must be your principal place of business.
If you have a separate space set aside for your home office, such as a spare bedroom or basement, it may be easy to demonstrate that you’ve met the first requirement. However, shared spaces can be problematic. A corner of the family room is unlikely to qualify since non-business activities are probably conducted there, as well. If you’ve purposely set aside the family room as your home office, though, you may be able to claim the deduction.
The second requirement can be confusing to some of my clients: your home office must be your principal place of business. This doesn’t mean you can’t go to another location for work each day. According to the Internal Revenue Service, you must “substantially and regularly conduct business” from your home in order to meet this second condition. Merely checking emails in the evening may not be enough. If you utilize a free-standing structure, such as a converted garage, you may not need to pass the principal place of business test.
There are exceptions around different kinds of businesses, such as home-based daycare centers. As with all tax considerations, you should consult with an accountant to determine whether or not your home office qualifies for the deduction.
How to Calculate the Home Office Deduction
If you meet the guidelines above, you may be able to claim the home office deduction. But how do you determine a dollar amount to deduct when filing your taxes? You can use the business percentage or simplified method to help arrive at this number.
The business percentage approach is based upon how much of your home’s space is used for work. You calculate this by dividing the square footage of your home office by the total square footage of your home, then multiplying by 100. For example, if your office occupies 300 square feet in a 1,200 square-foot home, your business use percentage would be 25%. You may then be able to deduct this against direct and indirect expenses (explained below).
The simplified method is more straightforward. Instead of calculating a percentage, you can take a deduction of $5 per square foot (up to a maximum of 300 square feet). You still need to have enough business income to cover the home office deduction. If you have a home office deduction in excess of the income for that year, you cannot carry the unused amount forward.
Costs that apply only to your home office are considered direct expenses and are usually fully deductible against business income. This could include things like painting walls, putting in new flooring, or converting a closet to a file storage area.
Funds spent to keep up your home are indirect expenses. This includes things like mortgage interest (or rent), property taxes, insurance, utilities, maintenance, and janitorial services. These are deductible based on the business percentage. You can find more information about deducting expenses on the IRS.gov site or can contact a tax advisor or accountant.
Implications for Your Income
The home office deduction can reduce your taxable income. Substantially shrinking your taxable income can make your business look like more of a risk to potential lenders. The home office deduction is one of the rare instances were you can save money without reducing your taxable income in regard to loans and that makes it attractive to many business owners.
If you’re interested in learning more about your business taxes, check out one of the articles in our Proactive Small Business series – Navigating Your Taxes and Regulations.
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