Do you use part of your home for business purposes? If so, you may be eligible for the home office deduction.
The home office tax deduction can be used whether you own or rent your home—this could mean significant tax savings.
"With proper planning, the home office deduction can offer some real tax savings to business owners who work from home," says Brendan O'Connor, senior attorney with RJS Law Firm, a tax resolution law firm.
"Business owners who work from home have the potential to write off many costs associated with their home that would otherwise be nondeductible," says O'Connor. "Taking the home office deduction can benefit a business owner's tax situation."
The home office tax deduction is beneficial for company owners who conduct part or all of their business from home, adds Cindy Dillard, CEO and partner of Small Business Accounting Tax & Bookkeeping Service.
The portion of the home attributable to the business must be used exclusively and regularly to conduct the business's administrative or management activities.
—Jennifer Correa Riera, partner, Fuerst Ittleman David & Joseph
"The deduction allows you to deduct a portion of expenses you pay to operate your home, such as mortgage interest and taxes, utilities, insurance, internet and phone and repairs," continues Dillard. "If you have space in your home to designate for business, you can get a tax deduction for something you're paying for anyways."
Eligibility Criteria for Home Office Deduction
"In order to be eligible to take the home office deduction, your residential space must either be used regularly and exclusively for conducting business or be the principal place of the business," says O'Connor.
According to O'Connor, the two key questions business owners should ask themselves are:
1. Do I have a dedicated space in my home for work?
2. Do I perform some or all of my job functions at home?
"If you can answer yes to both of these questions, I'd suggest exploring this deduction further with your CPA or tax professional, because it could mean hundreds and potentially thousands of dollars of tax savings, depending on your tax bracket," says O'Connor.
Regular and Exclusive Use
In order to qualify for work from home tax deductions, part of your home must be exclusively used to conduct business. For instance, if you have an extra bedroom, you can deduct expenses for that room, providing you only use it for work. (That means your home office can't also serve as a guest room.)
"There are exceptions to the exclusivity requirement," says tax attorney Jennifer Correa Riera, a partner with Fuerst Ittleman David & Joseph. "These include if you run a business licensed to provide day care services for children, handicapped individuals orpeople 65 or older. It also applies when the business's use of the home is for the storage of inventory or product samples."
Principal Place of Business
In order to be eligible for the home office tax deduction, the business must have its principal place of business at the home.
"Generally, that means the portion of the home attributable to the business must be used exclusively and regularly to conduct the business's administrative or management activities, such as keeping the business's books and records, billing customers or setting up appointments," says Correa Riera.
You may conduct business at a location outside of your home on occasion, but your home should be your main business location.
Additionally, you can deduct expenses for a free-standing structure that you use exclusively and regularly for your business—like a garage, barn or studio.
Determine a Home Office Tax Deduction Method
There are two ways to apply the home office tax deduction. The IRS refers to these options as the simplified option and the regular method.
"With the simplified option, entrepreneurs may deduct $5 per square foot for the space used in the home by the business," says Correa Riera. "This method is limited to a maximum of 300 square feet of space."
This results in a maximum deduction of $1,500.
As its name suggests, the simplified method is fairly easy to calculate, says Christopher Haas, founder of Haas & Sons Electric. He works from a home office.
"For me, the simplified version works best. It's much easier to figure out and requires less paperwork to sort through and store," says Haas. "The write offs have helped me balance my earnings and expense report, therefore paying fewer taxes at the end of the year."
If you find it difficult to keep records of all the various expenses involved in having a home office, then the simplified option may be your best option, according to Dillard.
"You might miss out on some deductible expenses, but it will save you time figuring out what you can claim and make record-keeping much easier," she says.
With the standard method, the home office deduction is based on the percentage of your home used for business, which is measured against actual expenditures. This allows you to deduct a portion of your mortgage interest, taxes, utilities, insurance, maintenance and repairs and other expenses.
"Let's say you have a 1,000-square-foot home and your office is 100 square feet, or 10 percent of the total area," says Haas. "You could write off 10 percent of your electricity, waste, heat, gas, water, etc."
"Using the regular method for home office deduction also allows a depreciation deduction for the percentage of the home used for the business's activities," says Correa Riera. "It's important to note, however, that a depreciation deduction may lead to possible capital gains issues when the home is sold or otherwise disposed of."
The regular method requires that you keep detailed records substantiating the expenses that make up the home office expense deduction, in case of an audit.
"It's also important to note that the overall home office tax deduction is capped at the income earned from the specific business," notes O'Connor. "That means the deduction can't be used to generate a loss."
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