If you are an entrepreneur, and use part of your home for business, you can save some money by taking advantage of tax deductions available for home offices.
We’re sure you’re glad about that, right?
The home office tax deduction applies to any home, be it a houseboat, an apartment, a single-family home, or freestanding structures. It is also available for both renters and homeowners.
This article will arm you with knowledge concerning how to qualify for home office tax deductions, expenses that can be deducted, and how to calculate your deductions.
Let’s get into it.
How do you qualify for home office tax deductions?
There are two primary conditions that you must meet to qualify for home office tax deductions. They are discussed below.
- Regular and exclusive use: To qualify for home office tax deductions, you must regularly use that space dedicated to business. Also, the part of your home that you use for business must not be used for any other purpose. For example, if you use a spare bedroom as an office and children playroom, you may not claim tax deductions on that space. Exclusive use doesn’t mean that your office must be in a separate room; however, the part of your home dedicated to the business must be exclusive to the business. There are two exceptions to the condition of “exclusive use.” The first is for people who provide daycare services for disabled individuals, children, or senior citizens in the home office. They can still claim tax deductions as long as they are licensed or approved under the state law as a daycare center. The second exception is for people who store business product samples or inventory in the home office; they can claim tax deductions.
- Principal place of business: To qualify for tax deductions, your home office must be the primary location for doing business activities like meeting clients, keeping books and records, setting up appointments, among others. Now, this doesn’t mean that your home office has to be the ONLY place you meet with customers. Still, you must be able to show that you carry out most of the significant business activities in the home office, and that most of your taxable business income emanates from the things you do in your home office. Since 1993 that the Supreme Court tightened the definition of “principal place of business,” it’s been challenging to prove that your home office is your principal place of business. Thus, you must keep a good record of your activities at the home office, including a log of the time spent working at that part of your home dedicated to business.
What expenses can you deduct?
Some of the items you can deduct if your home office passes the use test are highlighted below.
- Repair and maintenance of the part of your home dedicated to business.
- Converted or purchased household furniture used in the home office.
- Depreciation associated with the part of your home used for business.
- A percentage of your rent, or home loan interest, as the case may be.
- Cost of cleaning the home office.
- Utility costs associated with the home office.
- A percentage of the real estate taxes and interest costs before calculating payroll taxes.
How to calculate home office tax deductions
There are two primary options for calculating home office tax deductions – the simplified option, and the actual expenses option. Let’s examine them in detail.
The simplified option
In 2013, the IRS introduced a more straightforward method for deducting home office expenses. If you use this method, you only deduct $5 per square foot of your home office, up to 300 square feet, rather than deduct your specific expenses. This translates to the fact that you can only deduct a maximum of $1,500. Even though the simplified option is relatively easy to use and requires less stress, it will give you a smaller tax break.
Some of the limitations of using the simplified option are:
- You can’t use it to take a business loss.
- You can’t capture home depreciation.
- You can’t carry over any part of the deductions to the future.
The simplified option deductions are taken directly on Schedule C.
The actual expenses option
This method involves deducting your specific business expenses from your total payable tax. For example, if the area of your home that you dedicate to business is one-tenth of your total home size, 10% of expenses like electric, gas, and water bills, rent or interest on mortgage, and home insurance costs can be deducted from your payable tax. Also, a portion of the depreciation on your home, and property taxes can be deducted from the payable tax using the actual expenses option.
For expenses that are specifically made for the home office, like paintings, room repairs, furniture, among others, you can deduct the entire cost from the tax.
How do you make deductions using the actual expenses method?
First, you calculate the space taken by the home office. You can do this using either the Area method or the Number-of-rooms method. To use the area method, divide the home office area by the total home area, and multiply by 100. For example, if your home office is 300 square feet, and your total home area is 3000 square feet, your office space is 10% of your total home area.
To use the number-of-rooms method, divide the number of rooms dedicated to business by the total number of rooms in your house. More often than not, people use the area method, because most homes don’t have equal-sized rooms.
Second, you have to itemize the deductible expenses. You can check out the list of eligible expenses in the IRS Publication 587, Business Use of Your Home.
Lastly, separate the expenses into direct and indirect. The direct expenses are those incurred only on the home section dedicated to business, while indirect expenses are those incurred for running the house itself.
This was definitely a lot of information on home office deductions… we are here to help you with any questions!
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