The Internal Service Revenue in the U.S. has ruled that personal homes used for business purposes will receive home off tax deduction on personal 1040 Tax Return. Taxpayers will need to meet the IRS’s requirements while maintaining good, clean records to qualify for this deduction. Your home office deduction is based on the square footage used for business.
Suppose you have been using a big chunk of your home regularly and only for business-related operations. In that case, the IRS will allow you to cross off the associated utilities, rent, repairs, real estate taxes, maintenance, and other relevant expenses.
The information below is everything small businesses and new start-ups should know about the Home Office Tax Deduction.
The Criteria to Qualify for Home Office Tax Deduction
Small business owners can claim the Home Office Deduction regardless of whether you are a homeowner or a person who rents out the house. Any type of house can be used to qualify for this tax, such as a single-family house, an apartment, a houseboat, or an apartment. Keep in mind that the premises are not being used as a hotel or any form of temporary lodging. The rules and regulations of Home Office Tax Deduction also apply to freestanding structures of your house. This includes studios, garages, even a barn space that can be considered your home office as long as the freestanding structure successfully meets the regular use and exclusive requirements of the Home Office Tax Deduction.
Any small business or entrepreneur who wants to qualify for this tax must meet the following conditions:
The space should not be multipurpose:
The area where you conduct your business should not be used for anything else. Let’s say you use you have converted your personal garage to your home office and you use it to conduct administrative tasks. You cannot use it for car parking if you want to apply for a tax deduction at any time. In other words, the Tax deduction for the home office is not effective on the spaces used for dual purposes, however, IRS has stated two exceptional conditions where dual-purpose spaces can be eligible for a home office tax deduction.
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- Inventory: If you use the same space to conduct client meetings and other administrative tasks but you also use it to store the products of your business.
- Daycare: If you provide daycare services for the elderly (aged 65 or 65+), impaired ones, or children in that space, you’re still eligible for a home office tax deduction for that space.
Primary business conducting capacity
There are enormous businesses with different business natures, it might be possible that your business cannot be conducted within four walls space. It is not necessary for a business to be able to operate indoors. It is still eligible for a home office tax deduction if a certain space is used for prime business activities. These activities can be administrative activities like taking care of bills, management, planning, etc.
Methods to Determine Your Home Office Deduction
If you’re wondering how you can estimate the relief you’ll be getting with a home office Tax deduction, the IRS has proposed two methods for calculating this.
Simplified method
The simplified method does not actually deduct your expense but it gives you an amount per square foot that you can save from overall Tax expenses. IRS has prescribed a rate of $5 (for a space up to 300sqft) to be multiplied by the number of total square feet that make the area of your home office. The maximum amount you can get off of your tax in this case is $1500 in the case of 300sqft home office space.
This does not include any hard and fast maths rules and is pretty straightforward.
Actual Expense Method
This method is a regular one and involves a bit of technicality. This has no limit as the simplified method as it is based on a percentage of your overall residential expenses.
For this method, first, you will divide the space of your home office (sqft) with your overall home’s space (sqft). This is will give you some percentage value. Now this percentage decides how much deduction you’ll be getting. You can do this by multiplying the percentage by the sum of the total expenses of your home.
Let’s say your home space is 2000sqft whereas your office area is of 400sqft. When you divide, you’ll be getting a percentage of 20%. This shows that you’ll be getting a 20% relief from your overall home expenses.
Actual Expense vs. Simplified Method
If you are eligible for Tax deduction according to the eligibility criteria as per IRS’s description, the next question is to decide which deduction method you pt for. This decision completely depends on which one of these methods gives you a larger deduction over the tax rate for the current year.
The actual expense will be multiplied by the percentage of the square used for business. For example, 20% used for business will be multiplied by the actual utilities, home/repairs (permanent repairs). To calculate the deduction with the simplified method, you will multiply your client’s total home office space by the rate per square foot for the current tax year
The actual expense method gives you get full relief from direct expenses while the indirect expenses can be deducted based on the percentage. Mortgage interest, rental payment, utilities and bills, insurance, etc., come under the umbrella of indirect expense while the direct expenses can be related to the painting job, repair, or others.
If your office area is less than 300 sqft, it makes more sense to go for a simplified method as the main advantage is that it subtracts the time that will be consumed while gathering all the records/ receipts. If you calculate this with the method of actual expense, you will end up with something around $50 plus the time consumption in the whole process.
Things to Keep in Mind
- Record: Keep all the records handy with you related to Utility bills, house repair, electricity, and other bills if you’re planning on deducting your tax with the actual expenses method. This will help you a lot during the step of records and receipt verification by the IRS.
- IRS policies: Carefully go through all the related IRS publications just to be clear of different scenarios. These include the policies about selling your home for which you’re availing Tax deduction.
- Overcome the fear: Do not get intimidated by the audit policy and not avail the home office Tax deduction
- Selling your home: If you’re availing home office tax deduction with actual expense method, chances are that you may not be able to ignore capital gains Tax at the time of selling your home.
- Depreciation: This again applies on the citizens who are enjoying the home office Tax deduction via actual expense method. When you decide to sell your home, you have to be aware of the fact that the percentage of your tax deduction you get (let’s say 25%) will be the same percentage that can be subtracted from the sale profit of your home. Let’s consider, you avail a 25% of home office tax deduction on you overall expenses, when you go ahead and sell your home, the profit that you make from it will be subtracted. 25% of the profit that you make will be given as capital gains tax.
Both the last two points are applicable to the individuals who avail home office tax deduction via actual expense method, not to the ones who avail simplified method.
Home office tax deduction rules can be intimidating however ignoring them is not the solution. The best option is to consult a Tax specialist or use reliable online software. eProTax has got your back if you can’t figure out the whole home office tax deduction process. Our Tax specialists are just a call away and you can get this sorted without stepping out of your home.
