You’ve decided to start a small business working out of your home. Life is great, and you can’t beat the commute!
Now I’m sure you’re wondering how working from home will affect your income tax. Can you deduct expenses for use of your home? As you might have guessed, the answer depends on a lot of variables (isn’t that always the way with tax deductions?)
In order to be eligible to claim the home office deduction:
- Your business must be for profit (or an expectation of profit)
- You must set aside an area in your home that is exclusively for your business. If you set up your spare bedroom with a desk, some filing cabinets, and use it ONLY for business, then yes, it will be deductible. Warning: As soon as you add a sofa bed in the corner for dear Uncle Jim to use when he comes for a visit, the entire space is no longer exclusively for business and only the part exclusively for a business (i.e. the desk) is deductible.
Eligible for Deduction?
Time to bust out that calculator! First, you need to determine the total square footage of your home, and then of your office space so you can determine what percentage of your home is eligible.
Here’s an example. If your house is 2000 square feet, and your office is 200 square feet, you have a 10% office usage.
So, what does this mean? You will then be allowed to deduct 10% of your costs for the upkeep and maintenance of your home which includes insurance, taxes, mortgage interest (or rent if you do not own), electricity, gas, and repairs (if it affects the business space. A kitchen repair wouldn’t work) for the entire house. Additionally, you can take specific fix-up and maintenance costs in full if they are solely for the business space. Think new carpeting for the office.
Another deduction available to you is depreciation on your home. This is a trickier calculation (and one that I’d advise you get help with). You need to use the cost of the house, less the value of the land, and then depreciate this value over 39 years (if you’re thinking “why 39 years?”, it’s because that is the commercial use value).
The Simplified Option
You now have the option to claim your Home Office Deduction using a new method called the “Simplified Option”. What does this mean? The Simplified Option allows you to take a standard deduction of $5/square foot (maximum 300 square feet) for the section of your home that you’re claiming rather than maintaining records of actual, legitimate expenses for your deductions.
With the Simplified Option, you don’t work with depreciation. If you want to take a depreciation deduction for the area of your home that you use for business and recapture that depreciation when you sell your home, then you’ll have to stick with the Regular Method.
Loss carryover is affected, too. Using the Simplified Option, you cannot:
· Carry over any amount that exceeds your gross income limitation, or
· Claim a loss carryover that was derived from the use of the Regular Method in the previous year.
One thing that’s stayed the same in both is this: the Home Office Deduction can’t be higher than the gross income you’re declaring from the business use of your home minus business expenses. For example, if your business’s net profit was $1,000 and the home office deduction is $1,500, you won’t be able to take the deduction.
If you’re not sure which method is best for you, contact us at firstname.lastname@example.org and we’d be happy to help you figure it out.
FREE Home Office Deduction Guide
Do you want to know even more about Home Office Deductions? Get the Home Office Deductions Guide!