If you have a home business, you want to be able to claim the expenses associated with this business on your tax return. As with a business in any other location, you are allowed to claim a deduction for use of this space on your business tax return.
To qualify for this business tax deduction for your home business, you must meet certain basic requirements. This article explains these requirements, shows you how to calculate the deduction percentage, and explains the specific expenses you can deduct from your taxes if you qualify.
This deduction is for self-employed business owners. Employees working from home can no longer take a deduction for home office expenses on their tax returns. The miscellaneous deduction for unreimbursed business expenses has been eliminated, effective with the 2018 tax year and going forward.
First Qualification: Use of the Space
The first thing you must do is to determine if the space for your home business meets IRS requirements:
For-profit Business. The business must be legitimate; in other words, the intention must be to make a profit, not just a hobby.
Principal Place of Business. The space must be used as your principal place of business or for specific business purposes, like meeting clients or doing business paperwork. If you have more than one business location, consider the amount of time spent at each location and the relative importance of activities at each location.
Regularly and Exclusively. The space must be used "regularly and exclusively" for business. It can't be used just occasionally, and it can be used ONLY for business. If you or your family use this designated space for anything other than business, the deduction could be disallowed.
The IRS considers each situation on a case-by-case basis. See this article about how to make your home office more audit-proof to see some examples of "regular and exclusive" use restrictions.
Two Methods for Calculation
The IRS allows two different methods of calculating your deduction:
- Simplified Method: If you have a small space, you may use the simplified method, which allows you to do a simple calculation.
- Detailed Method: If you have a larger space or you have a complicated situation, you will need to use the more detailed method.
You can use either method for any one year and change to the other method in future years.
The Simplified Calculation Method
The IRS allows you to make a simple calculation for small office spaces. Find the square footage of your home office space and multiply that by $5 a square foot. The maximum space is 300 square feet, for a maximum deduction of $1,500.
There are some limitations to this method:
- You can't take a home depreciation deduction or recapture depreciation for years you use this method,
- You can't use the deduction to take a business loss,
- And you can't carry over any amount to a future year.
The Detailed Method
To use this method, you'll first need to calculate the space in your home used for business (regularly and exclusively, of course). You will be doing these calculations on IRS Form 8829 and including this form on your business tax return.
The space used for the business is determined by one of two methods:
- Area Method: Divide the area used for your business by the total area of your home. For example, if your home is 2000 square feet and your home office is 400 square feet, your office space is 20% of the total area of your home.
- Number-of-Rooms Method: Divide the number of rooms used for business by the total number of rooms in the home (use this method if the number of rooms is about the same).
In most cases, the area method is the best, since most homes do not have rooms of equal size.
Itemize Home Office Expenses. The next step is to determine the kinds of home business expenses you can deduct. In addition to your other business expenses, the IRS allows you to deduct and indirect expenses that are related to the "business use of your home."
Be careful to separate business expenses from personal expenses. Then separate expenses into two categories:
Direct expenses are those used only for the business section of your home. An example would be paint, wallpaper, and carpeting used only in that area. You can deduct these expenses at 100% because they are only related to your business.
Indirect expenses are those paid for running your home which can be deducted based on the percentage of the home used for business (see "Calculating Your Home Office Space Deduction"). Typical indirect expenses include rent/mortgage interest, utilities, insurance, and general home repairs.
To determine the total indirect expenses, list all of your total home expenses for the year. Here is a partial list:
- Rent or Real estate taxes
- Deductible mortgage interest
- Homeowner's insurance premiums (unless you have separate insurance for the business part of your home)
- Some home repairs (if they affect the home business space)
- Utilities and services, such as electricity, gas, trash, water, and sewer. (Telephone expenses are discussed below)
- Depreciation. To calculate depreciation on your home, use the lesser of (a) the fair market value of your home on the date you first used it for business, or (b) the purchase price (excluding land) plus major improvements minus casualty losses or other changes to your home's basis.
Total the indirect expenses and multiply them by the percentage of your home, as you calculated above.
You can't deduct home expenses that aren't related to your business. For example, if you put in a swimming pool or a new deck on another part of the house, you can't deduct these costs as business expenses.
Expenses You Can Deduct Elsewhere on Your Tax Return
Advertising, salaries, and supplies expenses are not deductible as "business use of the home," but they may be deductible elsewhere on your tax return. You might also have a difficult time convincing the IRS that a landscaping service is a legitimate business expense unless you regularly have customers who come to your home for your services.
Deducting Telephone Expenses for Your Home Office
If you want to deduct your telephone expenses for your home office, here is what you need to know:
If you have one telephone line in your home:
If you have only one telephone line in your home, you cannot deduct the use of the phone line for local calls, since that is not "exclusive" use of the line, under IRS regulations. But you can deduct any long-distance business calls you make on the line. Be sure to save your phone receipts so you can show the detail on the specific calls made if you are audited.
If you have separate business and personal phone lines:
If you have set up a separate business line in your home, you can deduct the use of this line for both local and long-distance calls. Be sure you do not use this line for personal calls. Remember the "exclusive" provision.
If you use a cell phone for business:
You can deduct expenses for a cell phone used exclusively for business in the same way as a wired phone. If you have only one cell phone and you use it for both business and personal calls, check with your tax professional on deductibility.
Limits on Home Office Business Deductions
Even if your home office and the business expenses associated with that office are otherwise deductible, your deductions may be limited,
If your gross business income is less than the total amount of your business deductions, your deduction for certain expenses for the business use of your home is limited.
Your deduction of otherwise nondeductible expenses, such as insurance, utilities, and depreciation (with depreciation taken last) is limited to the gross income from the business use of your home minus the sum of the following:
- The business part of expenses you could deduct even if you did not use your home for business (such as mortgage interest, real estate taxes and casualty and theft losses);
- The business expenses that relate to the business activity in the home (for example, salaries or supplies), but not to the use of the home itself.
If you cannot deduct all of your expenses and depreciation because of the limit, you may be able to carry over some or all of these expenses to the following year. Check with your tax adviser for more details on this carryover allowance.
Calculating these home office deductions for years when you have a business loss is complicated. Get help from your tax professional before you make any decisions.
Your Home Office Deduction on Your Business Tax Return
How you claim this deduction depends on your business type. This article explains how to include the deduction on Schedule C and for partnership tax returns.