Running your own business is a great way to generate additional money while also receiving one or more tax breaks. Home-based enterprises are eligible for regular business tax deductions, and you may also be eligible for the home office deduction. When home business owners fulfil the Internal Revenue Service’s deduction standards, they can deduct a part of their mortgage and energy bills as a business expenditure. Because the home office deduction is fairly difficult, it’s advisable to speak with a professional tax consultant before claiming it for the first time.
Your home-based business has a one-of-a-kind tax position. You may claim all of the standard company tax deductions, but some apply differently to home-based enterprises and some are unique to running a business from home.
Being Eligible for a Home Business Tax Deduction
Your home business can claim two types of deductions: standard business deductions and deductions that you must qualify for as a home business.
Deductions for home offices are dependent on the percentage of your house that you utilise for business. Divide the square footage of your office space by the total square footage of your home to get this figure. It is critical that these calculations be correct and that you deduct just the proper percentage of each cost.
The major home business deduction is for your company space, and deducting the usage of your facility is a two-step procedure. Because you are conducting business from your home, you must demonstrate that the area you are utilising for business is:
- Your main location of business
- Being utilised on a regular and exclusive basis for your business
1. Main Location of Business
Before you can start collecting those tax deductions for your home company, you must first satisfy the IRS requirement that your house is your primary place of business.
If your house is your lone business location, it is simple to demonstrate that it is your primary place of business. You must be able to demonstrate that you do not have another fixed location where you do administrative or managerial operations such as paying bills, managing your business finances, and communicating with workers, suppliers, and customers.
However, if you work both from home and at an office or another place, you must consider two factors:
- The proportional significance of the actions carried out in each site
- How much time you spend at each location
According to the IRS, “you cannot deduct costs for the commercial use of your home if the use of the home office is just suitable and useful.”
2. Use on a regular and exclusive basis
In addition to ensuring that your house is your primary place of business, you must meet both of the requirements for routinely and exclusively utilising your home for business purposes.
- “Regularly” indicates on a daily, weekly, monthly, or quarterly basis, not just rarely.
- “Exclusively” indicates that your home office area can never be utilised for anything else. This includes keeping personal belongings or utilising your family dining table for Thanksgiving dinner.
On Page 4 of IRS Publication 587, Business Use of Your Home, there is a table to assist you determine if you qualify for a home business space deduction.
Both of these characteristics are considered by the IRS on a case-by-case basis when evaluating whether you may deduct home business costs. You must be able to prove that your house is your primary place of business and that you use it regularly and solely for business reasons. Keep note of what you do for your business from home (computer work, customer calls) and how much time you spend at home versus at an office.
How to Calculate the Deduction for Home Office Space
The IRS provides two methods for calculating the deduction for business space in your home:
- The traditional technique of estimating real expenditures
- A basic multiplication approach that is streamlined for tiny business sectors.
Both techniques are based on the part of your home where you do business on a regular and exclusive basis. This region might be a full room or a section of a room. You’ll need to calculate the square footage of the area used for business purposes for either approach.
1. Method of Actual Expenses
The most typical method of calculating the deduction is to compare the size of the business portion of your home to the total size of your home. You can split the square footage of your business area by the overall square footage of your house.
When you get the percentage, go over a list of home costs that you may deduct and apply the proportion of business space to those expenses. This technique of computation distinguishes between direct and indirect expenditures.
Direct costs are just for the business component of your house, and you can include all of them. Painting the room or purchasing materials for your home office are two examples.
The proportion is applied to indirect expenditures for your entire house. For example, if your home business area is 15% of your total home space, you can deduct 15% of your utility costs. 3
2. Method of Simplified Calculation
For smaller areas, the straightforward technique is preferable. To claim this deduction, multiply the business square footage by $5 per square foot up to 300 square feet, with a maximum deduction of $1,500 per year. 4
The benefit of this technique is that you don’t have to keep track of all your household costs and perform computations to find out the percentage. When using the simple approach, you cannot deduct depreciation.
Limits on Deductions for Home Office Space
The amount of deduction you may claim for your home business space expenditures using either calculating technique is limited. If your gross revenue from business use of your home is less than your total business costs, you can only deduct a portion of your expenses. These restrictions apply to nondeductible costs like as insurance, utilities, and house depreciation. These restrictions and computations are difficult to understand. 5
How to Report and Claim Your Business Space Deduction?
The calculating technique you employ determines how you report your business space deduction.
Fill out Form 8829 to use the real expenses approach. Include this form with your corporate tax return.
Calculate the deduction using the simplified method on Schedule C, Line 30, or the applicable part of your business tax return.
Questions and Answers (FAQs)
Is it true that claiming a home business tax deduction increases my chances of being audited?
There’s a widespread misconception that the IRS targets home-based enterprises. While this is not true, owning a home company implies you should be prepared if the IRS decides to inspect it. The IRS wants to make sure you’re not breaking the law by not using your home office “regularly and solely” for commercial reasons.
Did the Tax Cuts and Jobs Act of 2017 affect home business tax deductions?
There have been no specific changes in tax law for home-based businesses, but there have been some changes in the ability of businesses to take losses and increased depreciation deductions. You may also be eligible for the new Qualified Business Income deduction, which provides small business owners with an additional deduction on business income.
Can I claim this deduction for more than one structure on my property?
You can also deduct costs for a separate free-standing building, such as a studio, workshop, or garage, if you use it primarily and consistently for business purposes. It does not have to be your primary location.
Accounting advice for small firms that operate from home
Accounting is critical for any business, but home-based entrepreneurs must pay extra attention to their finances and costs if they want to save the most money during tax season.
Here are a few essential ideas to keep in mind throughout the year as you prepare for tax season:
- Make a distinct area for your company. If you want to claim a home office deduction, be sure your workplace fulfils the “exclusive use” requirement.
- Keep business and personal spending separate.
- Maintaining independent accounts for business and personal money can keep your records clean and organised when it comes time to assess your company’s income and spending.
- Keep track of any personal assets used for commercial purposes.
- If you use assets for both business and personal reasons, such as your laptop, mobile phone, and car, keep a record of any commercial usage so you can properly determine the proportion utilised for business.
- Estimated and self-employment taxes must be considered. Unlike in a typical employment, when an employer deducts taxes, Social Security, and Medicare contributions from an employee’s income, business owners must pay these fees themselves. Estimated quarterly taxes are typically required of sole proprietors, partners, LLCs, and S companies.
- Engage the services of an accountant. Independent web study can teach you a lot about accounting and tax rules, but nothing beats the counsel of an experienced expert. If you’re seeking for the best CPA or accounting firm for your company, read our guide on selecting an accountant.