Home Office Tax Deduction Guide

home office tax deduction guide

There is nothing more convenient that running a small business from home. You can start your workday without having to deal with the hustle and bustle of morning traffic, busy road construction, and other events that can cause you to arrive late. Plus, you can save time and money by making your breakfast and brewing a cup of coffee in the comfort of your home.

Another convenience of running a small business from home deals with income taxes. Simply put, the tax return preparation and filing process for a home-based business is fairly simple, so long as you maintain accurate records. Certain business-related tax laws and deduction amounts are known to change each year, so we recommend that you consult with a certified accountant to get reliable financial advice. In the meantime, this Balboa Capital blog post has some useful information. Think of it as your home office tax deduction guide.

Qualification requirements.

The IRS has rules in place that help home-based business owners save money on their taxes each year. If part of your home (e.g., studio, garage, spare bedroom, etc.) is used exclusively and regularly for business purposes, you can qualify for the home office deduction. For example, if you run a graphic design business from home and conduct all of your business-related activities from your home office, you can write off a certain portion of rent/mortgage, real estate taxes, utilities and other expenses.

In most cases, the space in which you operate your home-based business cannot be used for anything other than business. For example, a spare room might not qualify for the home office deduction if it doubles as a family entertainment room or a children’s playroom. That said, you might be able to write off a portion of a shared room. Contact your accountant to make sure, as every business owner’s situation is unique.

Home office deduction options.

When calculating your home office deduction amount, there are two options to choose from. The first option we will explain is the “simplified option” which, as its name implies, is relatively simple. With the simplified option, you can take a deduction of $5 per square foot for the room or area in your home that is used primarily for business purposes. The maximum amount of space that can be deducted is 300 square feet, which equals $1,500 per year. If you own a home or condominium, you can still write off your mortgage interest as an itemized deduction without having to allocate a percentage of it to your home office deduction.

The second option to consider is called the “actual expense method,” which involves more record keeping and number crunching. With the actual expense method, you need to add up your total home office expenses and measure them against your overall residence expenses. To give you a better idea of how this works, we came up with a sample scenario:

A computer repair business owner that runs her business from home paid $7,000 in mortgage interest and $4,000 in utility bills (indirect expenses), and $1,000 for home office improvements (direct expenses) last year. Her home office is 400-square-feet, and the total square footage of her house is 3,000.

To calculate her home office deduction, the computer repair business owner needs to add up her total indirect expenses ($11,000) and multiply them by the 13.3% of office space in her home. To get this percentage amount, she divided the square footage of her business space (400) by the total square footage of her home (3,000). She will then take this number ($1,463) and add $1,000 for the direct expenses to get a total deduction amount of $2,463.

Common expenses that are eligible for deduction with the actual expense method include mortgage interest, insurance, upgrades and repairs. The actual expense method is tailored for home businesses that operate in residences that have a significant amount of square footage.

Travel expenses for a home-based business.

If you need to travel by automobile, plane, bus or train for business purposes, you might be able to deduct certain travel expenses. Deductible expenses include, but are not limited to plane fare, automobile mileage, parking fees, lodging and meals.

Office equipment deductions.

Last on our list of deductions for home-based businesses is office equipment. After all, it would be impossible to run a business without office furniture and a computer, printer and telephone, and the like. Most types of office equipment are deductible in the year they are purchased under the Section 179 tax deduction, so ask your accountant about this special IRS provision.

Accurate records are key.

Running a home-based business frees up your time and enables you to have more control over your schedule. That means you will have time to stay on top of your income and expense records throughout the year. Keep all of your receipts in a folder, and use accounting software to record of your financial information. Cloud-based accounting software is a great option because it reduces paperwork and lets you pull real-time reports and track inventory, sales, and expenses. Moreover, accounting software is more accurate than traditional spreadsheets because it has built-in formulas and categories.

If you are diligent with your record keeping and do not fall behind, you will always have accurate books that are readily available. In addition, you will not have to gather everything during tax season and race against the clock to prepare your tax return. Hurrying through this process is stressful and can result in errors on your tax return. In addition, documenting and recording your expenses will come in handy if your home-based business is ever audited by the IRS.

The information in this blog post has been prepared for informational purposes only, and is not intended to provide, and should not be relied on for tax, legal, investing or accounting advice. You should consult with your accountant, lawyer or tax advisor before making any business decisions or moving forward with business funding.