One of the questions that I get asked on a regular basis is how to calculate the home office deduction for self-employed business owners.
So let's break this down into easy to understand terms to help you understand if you and your online business qualify for the home office deduction.
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Qualifications of the Home Office Deduction
What actually qualifies your online business for the home office deduction?
You must be using a part of your home for your home office and it must pass the home office deduction test that I've outlined below.
You can also be a homeowner or a renter to claim this deduction. All types of homes are available to use for this deduction as well.
But remember this is homes. Residences that are temporary, like hotels and AirBnB's do not count.
After you have determined that your home qualifies, you then must pass the home office deduction test.
Home Office Deduction Test
There are two conditions to the home office deduction test that you must pass:
1. Regular & Exclusive Use Test
The space that you are using for your home office must be used exclusively for your home office.
If you are using a spare bedroom, then this bedroom cannot also be used for guests to sleep in, even just a few times a year.
Your office cannot double as a playroom for the kids.
But if you have a space, like a corner of a room, that you have designated as your office, this does count as exclusive use for your office, and only the square footage of this space is what counts for the deduction.
This space must also be used regularly for your business, not once or twice a month and the other times you work out of a coffee shop or from your couch.
2. Principal place of business test
While your home office doesn't have to be the only place you run your business, it is the principal place where most of your business activities take place.
The IRS considers your home office to be your principal place of business if you conduct most of your administrative and managerial tasks from your office. These tasks include, but are not limited to:
- setting up appointments
- billing and invoicing your customers
- completing your bookkeeping and accounting work
In IRS Publication 587, the IRS gives some examples to explain the principal place of business test.
As an online business owner, this means that you can have an office space in your house that qualifies for the deduction. This space has to be used primarily for your business. But this space also cannot be a space like your living room couch, kitchen or dining room tables or kitchen counters. These spaces are not primarily used for business purposes.
What Home Office Expenses Can you Deduct
When you are claiming the home office expense deduction on your tax return, there are some expenses that you can claim and others that you can't.
But it also depends on the method that you use to complete this calculation (see below for the methods).
Obviously the expenses that can be included (and don't forget to keep copies of all statements, proof of payment and receipts) are:
- Repairs and maintenance to the business area of your home
- Utilities
- Real estate taxes
- Insurance
- Deductible mortgage interest
Let's dig into these expenses a little bit more and whether you can deduct them for your home office deduction.
Direct, indirect and unrelated home expenses and their qualifications
Direct expenses are those expenses that have to do directly with your home office space. These expenses are 100% deductible. They would include things like repairs and improvements to your office space.
For example, you built a wall to give yourself a completely private office space from the whole room that your office was in. The cost of building this wall is deductible fully.
Indirect expenses are those expenses that are used throughout your entire home. These are deducted based on the method that you chose to calculate the home office deduction. These expenses include: utilities, taxes, insurance, mortgage interest.
Keep in mind, your internet is used by others in the household for things other than just your business. Therefore, the business cannot deduct the whole cost of the internet from your revenue.
Unrelated expenses are expenses for the home that have nothing to do with your business. These expenses are not deductible at all. These include things like pool repairs, lawn care, gardening, garage repairs, etc.
Don't try to sneak in deductions that you know do not qualify. You will get caught and will have to pay more in taxes because of this.
Plus you must also remember to keep a copy of all of your deductions' statements, proof of payment and receipts with your business stuff.
The 2 Methods of Calculating the Home Office Deduction
Many business owners do not take the home office deduction because it can seem complicated to calculate and figure out. There are 2 methods that you can use to calculate your home office deduction.
1. Simplified Method
This method is called the simplified method because it really is quite simple. And you actually don't even need the home expenses that are listed above to use this method.
What you need:
- The square footage of your office space, which cannot exceed 300 square feet. This is known as the allowable area for tax purposes.
You will also need to know your net profit (total annual revenue minus total expenses) for the year for this method.
To calculate the simplified method:
Take your office space square footage and multiply it by $5.
For example, my office space is 200 square feet.
200 x $5 = $1,000
The other rule to this method, if you have a net loss for the year, you can't take this deduction. You must have a net profit.
The amount of your deduction is the lower of your net profit or your calculation.
So continuing with the example from above, let's say the net profit for the year is $1,200. The amount deducted would be $1,000 from the calculation because it's lower.
But if the net profit was $750 for the year, the amount of the deduction would be $750, not the calculated amount of $1,000.
2. Regular Method
The regular method is based on a calculation of the square footage of your office space as compared to the square footage of your entire house.
For example, the office space square footage is 200 square feet and the total house square footage is 2000 square feet.
You would take 200 and divide it by 2000, to get a percentage.
In this case, 200/2000 = 10%
Now you would apply this 10% to your the expenses as listed above under the indirect expenses. The direct expenses are 100% deductible for your business and do not need the home office deduction calculation.
Make sure that you keep copies of your statements, proof of payment and receipts for all of your home office deduction expenses.
You may be able to still use the home office deduction if you do not qualify for the simplified deduction because your expenses are greater than your income (or you realized a net loss) for the year.
And even with using the regular method when you realized a net loss, you may still not qualify for some deductions.
The Home Office Deduction Form from the IRS
Businesses that are sole proprietors and single member LLCs are the only businesses that qualify for the home office deduction. These businesses file a Schedule on the tax return. The form that is completed for the home office deduction is From 8829.
When you use a tax return software, tax preparer or an accountant, this form is filled out for you. When you file your own tax return, you'll need to fill out this form yourself.
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What Paperwork do I have to keep for this deduction?
You will need to keep copies of:
- Mortgage or rent statements
- Proof of payments
- Copies of utility bills
- Copies of insurance bills
- Receipts for repairs
- Square footage of your office space
- Square footage of your entire home
Keeping Your Home Office Deduction Paperwork Organized
Since you have so many documents that you need to keep for this deduction, you can keep these documents in their paper copies, or keep them in their electronic copies.
If you are anything like me, you get all of your bills sent to you electronically anyway. It's just easier that way and helps to cut down on the paper clutter.
So you can keep the electronic versions either in a folder in your email.
Or the way that I think is easier, create a folder on your computer for your business expenses. Each month you get a statement from any of the vendors for your home expenses, save that pdf to your folder with the name of the vendor, the month and year of the expense.
By keeping everything saved in a folder on your computer named this way, it makes it very easy for you to find something when you need it most.
Other Important Notes About the Home Office Deduction
If you are a food blogger, your kitchen, kitchen table and dining room table do not count as your office. They are not used exclusively for your business. (Have fun proving this to an auditor!)
You can use a small corner of your bedroom or even your living room as your office. But make sure that you get the actual square footage of the space you are using for your office to calculate this deduction.
This deduction is not something that you will put into your bookkeeping program, or even need to keep track of on a monthly basis. It is a calculation you will do solely at tax time.
You Most Likely Qualify for the Home Office Deduction
The home office deduction is one of the main deductions that many entrepreneurs do not understand how to calculate and can end up losing out on.
But when you have a guide like this to walk you through this deduction in detail, I really hope you jump on taking the deduction on your business tax return.
This deduction can seem scary and confusing, but if you still don't understand it after reading through this guide, then please reach out and let me know what is still confusing to you, because I really want to help you understand and get the most from this deduction every year in your business.
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