Ah, living the dream life: Your own business where you work out of your home in your pajamas. You can roll out of bed, go down stairs, get some caffeine (even though you got up at 10am), turn on your laptop and work while watching the sports news (or whatever is your guilty pleasure). You think to yourself “And I get to deduct expenses for my home office which doubles as my living room!”
First of all, I know very few small business owners who get to keep that schedule. Second, you don’t get to claim a home office deduction on your taxes just because you do work at your house. There are a few requirements that you need to meet:
- You need to use the area regularly and exclusively for your business. This means you need to use it not just occasionally, but on a regular basis. So you can’t set aside a section of the basement, use a few times a year, and call it an office. Additionally, you must use the area exclusively for business and not for personal use. So calling the living room your office isn’t going to cut it. There are two exceptions to the exclusive use rule: you use part of your home for storing inventory or product samples, or you use part of your home for a daycare facility.
- Your house must be your principal place of business for your company. Your home would qualify if (1) you use your home for administrative or management activities on an exclusive and regular basis, and (2) you don’t have any other fixed location where you do a large amount of your business’s administrative or management activities.
- You can claim a deduction for a home office if you meet with clients at your home, even if you also do business at another location.
- If you have a free-standing structure at your house that your use regularly for your business, you can claim expenses for a home office.
Meet all those tests? Great! Now it is time to figure out what you can deduct. There are two types of expenses, direct and indirect. Direct expenses are deductible in full, and are expenses that are for the part of your home that encompasses the area you use for your business. For example, if you painted your home office, the cost of the paint and supplies would be deductible. Indirect expenses consist of expenses for the upkeep of your home. This would include things like utilities, home owners insurance, and home repairs. Indirect expenses are deductible based upon the percentage of your home which your home office occupies. For example, if you paid $100 for home owner’s insurance, and your office encompasses 10% of your home, the deduction would be $10 (10% of $100).
Maybe you have heard that you can record some depreciation on your house as a business expense. That is true. What you would do is take the cost of your home, add in any improvements, and subtract any prior depreciation from a prior year. You would take this amount and multiply it by the percentage of your home you used in your business times the percentage of the year you used your home office. You would then take this amount and multiply it by a depreciation factor (called MACRS) you can get from the IRS literature. Your accountant can help you with this.
While the home office deduction has notoriously been a pain to figure out, the IRS has made steps to clear up confusion and streamline the process. Just this year they changed quite a bit of the process to make it much easier for taxpayers to use. The above criteria is the same, though, so don’t think you can claim more than you usually do just because they’re changing things up.
You now have two options when calculating your home office expense deduction: the regular option and the simplified option. Like the 1040EZ versus the 1040, there is a lot in the simplified option you can’t do. Some of the changes in the simplified option are allowable square feet, loss carryover, and home related itemized deductions claimed in full. For a full list of all the differences, check the comparison of methods chart at the IRS website.
While there is a lot to take in regarding the home office deduction, don’t let that stop you from considering taking the home office deduction. Additionally, don’t be afraid to ask an accountant for guidance if you have questions about the home office deduction. I always enjoy helping my clients understand their tax situation, and I would rather have you ask what something means than have you make a decision based on information about which you are confused. If you have questions, find a local accountant to give you a hand. We love to help people with their taxes, and always invite questions. You can also submit your questions in the comment section below, and I would be glad to answer them.
We’re frequently asked at events and on our Community forum about whether taking the home office affects selling your home. Please see “Will Taking the Home Office Deduction Affect My Taxes When Selling My Home?” for more information.
Chris Peden, CPA, CMA, CFM has over 15 years in the corporate world helping companies meet their regulatory compliance requirements. He also assists small business owners with organizing and making sense of their finance information. You can reach him at firstname.lastname@example.org. In accordance with Circular 230 Treasury Department Regulations, we are required to advise you that any tax advice contained in this article may not be relied upon to avoid penalties under the Internal Revenue Code. If you are interested in a written opinion that can be relied upon to prevent the imposition of tax-related penalties, please contact the author.