Home Based Business Deduction Limits with a Tax Loss

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Business owners who work from home can deduct both direct and indirect costs for the home-based business if the business has a profit for the year, but some of these costs are limited if the business has a tax loss for the year. First an explanation of these deductions,  then a process to follow for calculating deductions if the business loses money.

Before You Start Deducting Costs

Before we get into these costs, there are some basic requirements for deducting any costs for a home business space. The space you are basing your deductions on must be used BOTH  (a) regularly and (b) exclusively for business purposes, and it must be your principal place of business. 

Direct and Indirect Home Business Expenses

First, you must calculate the percentage of your home's square footage used regularly and exclusively by your business. It might be one or more rooms or a portion of a room. To do this calculation, measure the square footage of the business-use area, then divide that by the total square footage of the home. For example, if your home office is 200 square feet and your home's square footage is 1600 square feet, the percentage of business use is 12.5%.

Direct Costs

Then add up the amounts you spend on this portion of your home as direct costs. Direct costs are those related directly to the business portion of your home that you have set aside and used for calculations. These might include paint, wallpaper, or new carpeting. If, for example, you are carpeting the room where you have your business office, and only a portion of the room is used for business purposes, you will need to allocate the cost of the carpeting on a percentage basis, depending on what percentage of the room is used for business (this is different from the percentage calculation above).

Indirect Costs

Add up the indirect costs for your home business, that is, those home expenses which can be allocated to personal expenses and home business expenses. These indirect costs would include utilities, homeowner's insurance, general home repairs. The business portion of these indirect expenses would be the percentage of the home used regularly and exclusively for business.

Deduction Limits for Business Losses

If your business has a loss or if your business income is less than your home business deductions, your home business deductions are limited:

Your deduction for home business expenses that would otherwise not be deductible (that is, personal expenses like insurance, utilities, and home depreciation) are limited to the gross income from the business use of your home minus the sum of:

  • Home expenses you could deduct if your business were not in your home (mortgage interest and real estate taxes, for example), and
  • General business expenses not related to use of your home (supplies, depreciation on equipment, business phone). Don't include self-employment taxes in this list; it is calculated separately.

Carryover Expenses

If your deductions are greater than the allowable deductions for this year, you can carry over the excess deductions to next year. But the deductions for next year are still subject to the limit.

Calculating Home Business Deductions

To calculate your home business deductions, use Form 8829. This form walks you through the deduction process, including limits to the deductions. The total deduction from Form 8829 is included in your Schedule C for sole proprietorship income. The total allowable expense for business use of your home is entered on Line 30 of Schedule C.