If you elect to work from home, the federal government allows you to deduct your home office expenses from your income taxes. This is so whether you own or rent your home. Although this tax deduction is commonly called the “home office deduction,” it is not limited to home offices. You can also take it if, for example, you have a workshop or studio at home. Let’s walk through self-employed workers are deducting home office expenses the correct way.
Deducting Home Office Expenses the Right Way
You can take the home office deduction only if you regularly use part of your home exclusively for a trade or business. Unfortunately, the IRS doesn’t offer a clear definition of “regular use.” The only guidance the agency offers is that you must use a portion of your home for business on a continuing basis, not just for occasional or incidental business. You’ll likely satisfy this test if you use your home office a few hours each day.
“Exclusive use” means that you use a portion of your home only for business. If you use part of your home as your business office and also use that part for personal purposes, you cannot meet the test of exclusive use and cannot take the home office deduction. You needn’t devote an entire separate room in your home to your business. But some part of the room must be used exclusively for business.
This means, simply, that you’ll have to arrange your furniture and belongings so as to devote a portion of your home exclusively to your home office. The more space you use exclusively for business, the more your home office deduction will be worth.
Qualifying for the Deduction
Unfortunately, satisfying the requirement of using your home office regularly and exclusively for business is only half the battle. You must also meet one of these three requirements:
- Your home office must be your principal place of business.
- You must meet clients or customers at home.
- You must use a separate structure on your property exclusively for business purposes.
The most common way to qualify for the home office deduction is to use your home as your principal place of business. If, like many self-employed people, you do all or most of your work in your home office, your home is your principal place of business. You should have no trouble qualifying for the home office deduction. This would be the case, for example, for writers who do most of their writing at home or telemarketers who make most of their sales calls from home.
However, even if you work primarily outside your home, your home office will qualify as your principal place of business if both of the following are true:
- You use the office to conduct administrative or management activities for your business.
- There is no other fixed location where you conduct such activities.
What this means is that to qualify for the home office deduction, your home office does not need to be the place where you generate most of your business income. It’s sufficient that you use it regularly to administer or manage your business (for example, to keep your books, schedule appointments, do research, and order supplies). As long as you have no other fixed location where you regularly do such things (an outside office), you can take the deduction.
Calculating Amount of Home Office Deduction
There are now two ways to calculate the home office deduction. You can use the standard method discussed below. Alternatively, starting with the 2013 tax year, you may use a new simplified method.
To figure out the amount of the home office deduction using the standard method, you need to determine what percentage of your home you use for business. To do this, divide the square footage of your home office by the total square footage of your home. For example, if your home is 1,600 square feet and you use 400 square feet for your home office, you use 25% of the total area for business.
The home office deduction is not one deduction, but many. First, you are entitled to deduct from your gross income the percentage you use for your home office of:
- your rent if you rent your home, or
- depreciation, mortgage interest, and property taxes if you own your home.
In addition, you may deduct this same percentage of other expenses for keeping up and running an entire home. The IRS calls these indirect expenses. They include:
- homeowner’s or renter’s insurance
- home maintenance expenses that benefit your entire home, including your home office (for example, roof and furnace repairs or exterior painting);
- condominium association fees
- snow removal expenses
- and security system costs.
You may also deduct the entire cost of expenses solely for your home office. The IRS calls these direct expenses. They include, for example, painting your home office or paying someone to clean it. If you pay a housekeeper to clean your entire house, you may deduct your business use percentage of the expense.
If you own your home, the home office deduction is worth less because you’re already allowed to deduct your mortgage interest and property taxes from your income tax. But taking the home office deduction will allow you to deduct these items from your self-employment taxes. You’ll save $153 in self-employment taxes for every $1,000 in mortgage interest and property taxes you deduct. You’ll also be able to deduct a portion of repairs, utility bills, cleaning and maintenance costs, and depreciation.
Optional simplified home office deduction method
You have the option of using a much simpler method to calculate your home office deduction. Using this method, you just deduct $5 for every square foot of your home office. All you need do is get out your measuring tape.
For example, if your home office is 200 square feet, you’ll get a $1,000 home office deduction. That’s all there is to it. You need not figure out what percentage of your home your office occupies. You also don’t need to keep records of your direct or indirect home office expenses, such as utilities, rent, mortgage payments, real estate taxes, or casualty losses. These expenses aren’t deductible when you use the simplified method. Nor do you get a depreciation deduction for your home office.
Sounds great, but what’s the catch? The catch is that when you use the simplified method your home office deduction is capped at $1,500 per year. You’ll reach the cap if your home office is 300 square feet. Even if your home office is 400 square feet, you’ll still be limited to a $1,500 home office deduction if you use the simplified method. You can’t carry over any part of the deduction to future years.
MileIQ’s blog does not constitute professional tax advice. You should contact your own tax professional to discuss your situation.