Home Office Deduction
The home office deduction is an easy and effective way for small business owners and self-employed individuals to lower their taxes. However, we know that the home office deduction can be confusing. That’s why we wrote an easy-to-understand guide about the home office deduction.
Who Qualifies for the Home Office Deduction
Most self-employed individuals and small business owners that work from home qualify for the home office deduction. Unfortunately, if you are an employee working remotely, you do not qualify for the home office deduction.
To qualify for the home office deduction, you must meet one of the two criteria:
1. Exclusive and Regular Use
“Exclusive” means that whatever portion of your house you are using for business can only be used for business purposes. So, if you work from a desk in your bedroom, you will not be allowed to take the home office deduction. However, if you have a spare bedroom that you use as an office, you would most likely be able to write that space off as a home office.
There is no specific duration that constitutes “regular use.” However, suppose you are only occasionally using your home office. In that case, you will not be able to deduct that space on your tax return.
2. Principal Place of Business
Suppose your home office is the principal location of your business or a place where you regularly meet clients. In that case, you will qualify for the home office deduction.
If you have to travel to clients to perform services like a plumber or contractor, you will still be able to take the home office deduction. As long as you are performing some administrative or managerial tasks at your home office, you will qualify for the home office deduction.
How to Calculate the Home Office Deduction
There are two different ways to take the home office deduction. Therefore, it is crucial to determine which method benefits you the most when preparing your tax return. Always consult with a CPA before preparing your tax return.
Simplified Method
The simplified method allows you to deduct $5 for every square foot up to 300 square feet. So, if your home office is 200 square feet, you will be able to deduct $1,000 on your tax return.
Actual Expense Method
The actual expense method allows you to deduct a proportional amount of the following expenses based on the size of your home office. For example, let’s say your home office is 200 square feet and your entire home is 2000 square feet. In this case, you will be able to deduct 10% of the following payments on your taxes.
- Mortgage interest (but not mortgage payments)
- Rental Payments
- Home Insurance
- Utilities (Water, Gas, Phone, Telephone)
- Real estate taxes
- Depreciation
Things to Consider
Receipts
If you are planning on using the actual expense method, make sure you keep receipts of your expenses throughout the year. Keeping up-to-date receipts will help you and your accountant during tax season. Additionally, you will be prepared and stress-free if the IRS audits you. Save all mortgage, rent, insurance, and utility payments to a file to prepare for tax season.
Depreciation
If you are taking the actual expense method and own your home, you will be required to depreciate the value of your home. For example, let’s say your home is worth $500,000, and you use 20% of your home in your business. In this case, you are required by the IRS to depreciate $100,000 of your home value over a 27.5 year period. So each year, you would receive an additional $3,636 deduction on your taxes.
Home Sales
If you use the actual expense method to depreciate your primary residence, part of your capital gains tax exclusion will be disallowed. Typically, a married couple can exclude up to $500,000 in capital gains tax when they sell their primary residence.
Building off our previous example, let’s say you were using 20% of your home for your business and sold your home for a $200,000 gain. In this case, $40,000 of your profit will be subject to the capital gains tax. At an average capital gain tax of 15%, you will be required to pay an additional $6,000 in capital gains tax.
Conclusion
The home office deduction is a great way to save money on your taxes. However, each situation is different, so it’s important to talk to a CPA to determine which method is best for you.
At Windstone Financial, our team of CPAs has years of experience helping business owners get the most out of their deductions. Click the button below to get in touch with us and learn how to minimize your taxes.
