Your home-based business is in a unique tax situation. You can take all the usual business tax deductions, but some work differently for home-based businesses, and some are particular to operating your business from home.
Qualifying for a Home Business Tax Deduction
Your home business can take two kinds of deductions: the normal deductions that every business can take, and other deductions that you must qualify for as a home business.
The primary home business deduction is for your business space, and there's a two-step process for deducting the use of your space. Because you are doing business in your home, you must prove that the space you are using for your business is:
- Your principal place of business
- Being used regularly and exclusively for your business
Principal Place of Business
Before you start taking those tax deductions for your home business, you must meet the IRS qualification that your home is your principal place of business.
If your home is your only business location, it's easy to show that it is your principal place of business. You will need to be able to show that you don't have any other fixed location where you conduct your administrative or management activities, like paying bills, managing your business finances, and talking to employees, suppliers, and customers.
But if you work both at home and in an office or other location, you will need to consider two factors:
- The relative importance of the activities performed at each location
- The amount of time you spend at each location
The IRS says, "If the use of the home office is merely appropriate and helpful, you cannot deduct expenses for the business use of your home."
Regular and Exclusive Use
In addition to making sure your home is your principal place of business, you must satisfy both of the requirements for using your home regularly and exclusively for business purposes.
- "Regularly" means on a regular basis daily, weekly, monthly, every quarter, not just occasionally.
- "Exclusively" means that your home office space can't be used for anything else at any time. That includes storing your personal belongs there, or using your family dining table for Thanksgiving dinner.
IRS Publication 587 Business Use of Your Home has a chart on Page 4 to help you figure out if you qualify for home business space deduction.
The IRS considers both of these factors on a case-by-case basis in determining whether you will be able to deduct home business expenses. You will need to be able to support your claim that your home is your principal place of business and that you use it both regularly and exclusively for business purposes. Keep track of what you do for your business at home (work on the computer, talk to clients) and the amount of time you spend at home versus in an office.
How to Calculate Your Home Office Space Deduction
The IRS allows two ways to calculate the deduction for the space in your home that you use for business purposes:
- The normal method, calculating actual expenses
- A simplified method for small business areas involving a simple multiplication
Both methods are based on the area of your home that you use regularly and exclusively for business. This area might be a whole room or part of a room. For either method, you'll need to figure the square footage of the area used for business purposes.
Actual Expenses Method
The most common way to calculate the deduction is to compare the size of the business part of your home with the whole house. You can divide the square footage of the area used for your business by the total square footage of your home.
When you have the percentage, then you will go through a list of home expenses you can deduct and apply the percentage of business space to those expenses. This calculation method separates direct and indirect expenses.
Direct expenses are only for the business portion of your home, and you can include 100% of these expenses. Some examples are painting that area or buying supplies for your home office.
Indirect expenses are for your whole home; the percentage is applied to these. For example, if your home business space is 15% of your total home space, you can deduct 15% of the cost of utilities.
Simplified Calculation Method
The simple method is best for smaller locations. To take this deduction, multiply the business square footage by $5 per square foot for up to 300 square feet, for a maximum of $1,500 per year.
The advantage of this method is that you don't need to keep track of all your home expenses and run calculations to figure the percentage. You can't take a depreciation deduction when you use the simplified method.
Limits on Home Business Space Deductions
There are some limits on the amount of deduction you can take for your home business space expenses using either calculation method. If the gross income from the business use of your home is less than your total business expenses, your deduction for some expenses is limited. These limits apply to nondeductible expenses like insurance, utilities, and depreciation of your home. These limits and calculations are complicated.
Reporting and Claiming Your Business Space Deduction
How you report your business space deduction depends on the calculation method you use.
- For the actual expenses method, complete Form 8829. Include this form with your business tax return.
- For the simplified method, calculate the deduction on Schedule C, Line 30, or on the appropriate section of your business tax return.
Frequently Asked Questions (FAQs)
Does claiming a home business tax deduction increase my risk of being audited?
There's a myth going around that the IRS targets home businesses. While this isn't true, having a home business means you should be prepared if the IRS does choose to inspect your home business. The IRS wants to be sure you are not violating the requirement that your home office is used "regularly and exclusively" for business purposes.
Did the 2017 tax law changes (the Tax Cuts and Jobs Act) affect home business tax deductions?
There were no specific changes in the tax law for home-based businesses, but there were some changes in the ability of businesses to take losses and increased depreciation deductions, You may also be eligible for the new Qualified Business Income deduction that gives small business owners an additional deduction on business income.
Can I claim more than one building at my home for this deduction?
You can also deduct expenses for a separate free-standing structure, like a studio, workshop, or garage if you use it exclusively and regularly for your business. It doesn't have to be your principal place of business.