If you are a small business owner, freelance worker, or independent contractor who are working from home, you may be able to qualify for a Home Office Deduction.
Home office deduction allows you to deduct a portion of the cost of maintaining your home as a business expense.
If done right, this deduction can reduce your taxable income, creating a lower tax burden.
Just be careful, this deduction is either very useful, or conversely, taxpayers do not take enough advantage of it.
But, just because others use it to evade taxes doesn’t mean you shouldn’t take it if you qualify for it.
How the IRS defines the Home Office Deduction
Whether you convert a room, your basement or your garage into an office, the IRS does not specify what space an office can be.
However, they have two rules on the use of this space.
To qualify for this expense deduction for your business, you must use the home office to:
- Regular and exclusive use as your primary workplace.
- Exclusive and regular use as your meeting place with clients, employees – even patients – of your business.
And with regular use we mean that you use it constantly, not only on some occasions or for certain circumstances.
If you use your attic about three times throughout the year to hold a conference, it doesn’t qualify under IRS standards as regular use, so you don’t qualify for the home office deduction, either.
Also, if in this room intended as a home office, your children also use it to watch TV, it also does not follow the IRS guideline from home office.
Office Expenses that Count Towards the Home Office Deduction
There are three types of home office expenses according to the IRS.
You can see these expenses in publication 587 of the United States tax collection organization.
- Direct expenses that apply only in the office
- Indirect disbursements that apply to the home
- Unrelated expenses that do not apply to the home office
Direct expenses can be deducted in full.
Indirect expenses are proportionally deductible, according to the square footage of the office in relation to the square footage of the house.
Finally, unrelated expenses are not deductible.
Indirect expenses may include the following:
- Mortgage interest
- Mortgage insurance premiums
- Property taxes
- Rent (if you do not own the house)
- Repairs – unless it’s just from the office, then it would be direct
- Security systems
Note that phone costs are absent from this list.
The basic charge, including taxes, on the first line to your property is considered a personal expense and is not deductible.
However, long-distance calls attributable to the business can be deducted separately on Schedule C.
The cost of a second phone line to the home office for the business is a direct deduction.
A mobile phone plan can also be partially or fully deducted, depending on the percentage used in the business.
How to Calculate Your Home Office Deduction
If you opt for the general method using Form 8829, Home Expenses for Business Use, the first task you will have will be to calculate the percentage used in the business.
To do this, divide the square footage of the office space by the total square footage of your home.
For example, if the house is 1,000 square feet and your office is 10 x 10 feet (100 square feet).
The percentage of office space will be equal to 100 square feet / 1,000 square feet x 100 = 10%.
If you don’t know the area of your home, you can ask for help at the county assessor’s office.
The IRS allows you to use any reasonable method to determine the percentage of use in the business.
So if the rooms in your house are approximately the same size, you can divide the number of rooms used as an office by the total number of rooms in the house.
However, the square footage method is more accurate.
Let’s see the numbers
If the total monthly overhead is $15,000 a year – that is, the costs of maintaining your home.
So, you can only deduct 10% or $1,500 as home office expenses.
If during the year, you painted the office and the total was $300, you can add all of this expense, since it is a direct one.
So, you add $1,800 in deductions.
If you use form 8829, after calculating your home office deductions, you move on to depreciation.
For those who are not very familiar with this term, depreciation is a mechanism to deduct an amount for the normal use of your property during its useful life.
Continuing with the example above, let’s say the useful life of the property is 39 years.
To calculate depreciation you need the following:
- The base cost of the home as of the date you started using it as an office (usually the cost plus any improvements to the property). For example $ 300,000
- The cost of land: $ 50,000
- When did you start using your office: February 1, 2020
- The depreciation factor (you get it in the instructions for the form 8829): 2.461%
- The percentage of use of the business: 10%
Then, since the land is not depreciated, the calculation is done like this:
($ 300,000 – $ 50,000) x 0.2461 = $ 250,000 x 0.02461 = $ 6,152.50
The depreciation of office use is 10% of that $ 6,152.50 is:
$ 6,152.50 x 0.10 = $ 615.25
So the part that goes on form 8829, line 30 for home office use will be: $ 1,800 + $ 615.25 = $ 2,415.25
Not everyone wants to keep records of all their annual expenses in case of an audit.
Thus, to make taxpayers’ job easier, the IRS allows small business owners to select a simplified method of calculating an expense for office use.
This choice is made on Schedule C (part II, line 30), in which case form 8829 will not be necessary.
The simplified method allows a deduction of $ 5 per square foot up to a maximum of 300 square feet.
Therefore, for our 100 square foot example, the simplified method will allow you to deduct 100 x $ 5 = $ 500, which is significantly less than the depreciation method explained above.
Also, with the simplified method, you are not allowed to deduct for depreciation.
Exceptions and additional deductions
If you use an area to store inventory in your case, for example, the general area does not have to be used exclusively.
The area used as a warehouse unit where you keep your inventory can be included in the deduction, even when all the space is not used exclusively for the business.
Also, if you have a day care at home, special rules apply, which are detailed in IRS publication 587.
Be careful, if your business gross income is less than deductions (including home office), some deductions may be limited.
If you use the general method, rather than the simplified method, some of those deductions may carry over to next year. Again, you’ll find the details in publication 587.
Another caveat: if you’re using the general method, and you include expenses that are otherwise deductible in the standard deduction on Form A (such as mortgage, interest, property taxes and mortgage insurance) the percentage of those indirect expenses not used on form 8829 are still deductible on Schedule A.
Last Thoughts on Home Office Deductions
Home office deductions can save you a substantial amount in taxes.
If you are a small business owner who wants to cut costs, start collecting all your receipts, account statements and checks to pay the rent to calculate and justify the deduction from your home office.
Reducing the net profit of your business not only reduces your income tax, but also your self-employed tax.
Do you want to get the most out of all possible tax deductions?
Just contact us now – we will help you seize your deductions to the most.