Ask the Expert: An Explanation of the Home Office Deduction for Work From Home Small Business Owners
Have you filed your tax return yet? If not, you are in good company. Plenty of small business owners have more work than they can handle, especially those who work solo or operate with skeleton crews.
Fortunately, there are still a few weeks left to submit your return if you filled an extension. While completing your return, it may be worth your time to investigate the home office tax deduction. As long as you qualify, it's a great way to reduce your overall tax burden. Here is a basic explanation of it and how it works.
How Can You Qualify?
There are two sets of criteria that must be met in order to qualify for the deduction. The first is that your home office must be used for the "exclusive and regular use" of running your business. So if your use your home office for both personal and business purposes, you do not qualify. Furthermore, you cannot claim the deduction if your home office is only used for occasional or incidental business use. As a quick caveat, should you happen to run a daycare facility or run a business that involves the storage of inventory in your home office, you do not need to pass the exclusivity test.
The second set of criteria is that your home office must be the principal place of your business. What that means is that it is used exclusively and regularly for management or administrative activities involved with your business. Note, however, that does not mean that you cannot have another location where you conduct business, such as meeting with clients or customers. Just that your home office is the principal location - or where you do the majority of your work - compared to that of a secondary location if you have one.
What Can You Deduct?
There are several expenses that you can deduct under the home office deduction. They include service and utility bills, mortgage interest, real estate taxes, certain insurance coverages, an installed security system, some home repairs, rent payments, home depreciation, and the depreciation of business furniture and equipment, among others. Consult IRS Publication 587 for more detail and expenses you can deduct.
How to Take the Deduction
There are two different methods you can use to deduct home office expenses. You can use actual expenses and calculate the amount of those that apply specifically to your home office, or you can use a simplified method that makes the calculations much easier (though may not net you as large a deduction).
Expenses that are solely for your home office can be deducted entirely - for instance, a dedicated phone line or water service. However, for items such as utilities - that you spend on the entire upkeep of your home - you can only deduct a percentage. The percentage you can deduct is equivalent to the size of your home office as it relates to the entire square footage of your home. Let's say that your home office is 100 square feet and your home is 1,000 square feet. That means that 10% of all these expenses can be deducted. But there is another limit of sorts: If the gross income arising from the business use of your home is under your total expenses, the ability to deduct some of those bills may be limited.
There is also a second, much easier way to claim the deduction, although you might not receive as much of a benefit. With the recently introduced simplified version of taking the home office deduction, you avoid a lot of the calculation process, and simply determine the square footage of your home office and multiply it by $5. You can only claim a home office of 300 square feet or less, capping the deduction at $1,500. You may want to estimate your overall deduction first using the actual expenses method before going this route so you're not leaving money on the table. The tax prep software you use guides you through the actual inputting of these numbers, and most manual filers will use Schedule C associated with Form 1040. If you use the simplified version of the deduction, you'll use Schedule A.
A qualified tax pro can help you better understand your options; however, most tax prep software will walk you through the home office deduction as well (and at lower cost). Consult IRS Publications 587 and 946 for more help on this deduction in general.
Remember, no matter what you may have heard, taking the home office tax deduction does not necessarily trigger an audit or raise a red flag with the IRS. If you truly qualify for it, then take the home office deduction.
Be sure to consult with a qualified tax professional and keep bullet-proof records supporting your deductions. After you either enjoy a smaller tax bill or larger refund, your business and its bottom line will thank you for it.
Are you taking the home office tax deduction this year?
Seth Jackson is a contributor who writes about real estate, taxes, and personal finance.