Tax Deductions for Home-Based Businesses

Your home-based business is in a unique tax situation. Your home business can take all the usual business tax deductions, but some work differently and some are unique to home businesses.

Two Kinds of Home Business Deductions

Your home business can take two kinds of deductions. There are deductions you and all other businesses can take, and there are 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 (a) your principal place of business and (b) being used regularly and exclusively for your business.

After you are sure your home business space is qualified for the deduction, you can determine which method to use and which expenses you may claim.

01
Understand the Principal Place of Business Concept

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. But if you work at home and in an office, you will need to consider two factors:

  • The relative importance of each location
  • The amount of time you spend at each location

The IRS considers both of these factors, so you will need to be able to support your claim that your home is your principal place of business. Keep track of what you do for your business at home (work on the computer, see clients) and the amount of time you spend at home vs. in an office.

02
New Alternative: Simplified Home Office Space Calculation Method

The IRS has announced a new simpler calculation method for home office space deductions. You can deduct home business costs for the space used "regularly and exclusively" for your home business using the old calculation or the new simpler method. If you have a smaller space, the simple method can save you time and mistakes.

The simple method is best for smaller locations. You can deduct $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, but it's a method for a small area.

03
Calculate Your Home Business Space Deduction

This article takes you through the process of calculating your home business space deduction, using Form 8829 or the simplified method.

In brief, the process involves:

  • Figuring the space you will be using for your deduction and the usable space of your home
  • Listing all home expenses that can be used to calculate your deduction—some are direct and some indirect
  • Trying out both the simple and detailed calculation methods to see which is best for your home business

04
Use Form 8829 to Calculate Home-Based Business Expenses

Once you have decided to use the detailed method to calculate your home business deduction, it's time to begin working. To correctly calculate deductions for business use of your home, you will need to complete Form 8829:

  • Part I calculates the percentage of your home used for business.
  • In Part II you will enter both direct and indirect expenses for your home business space. 
  • Part III is the calculation of depreciation. (You can't use depreciation if you are using the simplified method.) 
  • Part IV is a carryover of expenses for another year. 

05
Prepare for an IRS Audit of Your Home Business

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.

06
Limits on Home-Based Business Deductions

Home-based business deductions are limited. You can deduct home business expenses to reduce y our business income for the year, but you can't take these deductions if they result in a business loss. The calculation for this limit can be complicated, but there are many resources to assist in its completion.

07
Deducting Travel Expenses To and From a Home-Based Business

If you operate your business from your home, you can deduct business-related car expenses for travel back and forth for business purposes, under certain circumstances.