Does your tax return include all of your business expenses?
If you’re self-employed and work out of your home, you may not be taking full advantage of the home office deduction. Figuring out the tax deduction is complicated, but the dollar amount will reduce your taxable liability.
For starters, you need to understand the tax forms and the documents you must file.
Reporting net profit for your business
Small business owners who are self-employed report their business income and expenses on Schedule C.
Part 2 of the tax form lists expenses for the business use of your home. Small business income less expenses equals your net profit, and the profit is added to other sources of income on Form 1040, the personal tax return.
Business profit is added to interest income, dividend income and possibly to your spouse’s W-2 income (if you file jointly). The IRS uses total income on Form 1040 to calculate your tax liability.
The home office tax deduction is calculated using Form 8829.
Using Form 8829
Completing Form 8829 can be time-consuming.
Fortunately, many self-employed people can take the home business deduction using the simplified method. The IRS makes this important point regarding this easier method: “This simplified option does not change the criteria for who may claim a home office deduction. It merely simplifies the calculation and recordkeeping requirements of the allowable deduction.”
Applying the simplified method
The method offers a standard deduction for home office expenses:
- A deduction of $5 per square foot of the home that is used for business, up to a maximum of 300 square feet.
- You can deduct home-related itemized deductions in full, using Schedule A. These deductions include mortgage interest on your home loan and real estate taxes.
- If you use the simplified method, you cannot deduct depreciation expenses on your home.
Employees who work from home
Tax reform legislation has eliminated the home office deduction for employees. The Tax Cuts and Jobs Act (TCJA) removes the deduction for tax years 2018 to 2025.
If you generate income from self-employment and don’t qualify for the simplified method, you use the regular method.
Working with the regular method
This method requires that you report your actual expenses for a home office.
Typical office expenses include mortgage interest, insurance premiums, utilities, repairs and depreciation expenses. Business expenses are calculated using the square footage of your home that includes your home office.
The regular method has two requirements.
Regular and exclusive use
The IRS states that: “You must regularly use part of your home exclusively for conducting business. For example, if you use an extra room to run your business, you can take a home office deduction for that extra room.” The space does not need to be marked off by a permanent partition.
There are two exceptions to the exclusive use rule:
- Inventory: If you use part of your home to store inventory or product samples, you do not have to meet the exclusive test.
- Daycare facility: These types of business activities do not have to meet the exclusive test.
In addition, your business must be a profit-seeking venture. If you simply manage your investments from home, you don’t meet the regular use rule. The part of your home must be used for a business that generates a profit.
Your home office must also be your principal place of business.
Principal place of business
To meet this requirement, you must use your home “substantially and regularly” to conduct business.
- If you normally meet with clients and customers at your home, you will qualify for the home office deduction. You can conduct business at another location and still use your home regularly for work.
- Some business owners use a separate structure, such as a studio or garage. You can deduct expenses for these structures, if you use them regularly for business.
Your home is your principal place of business if: “You have no other fixed location where you conduct substantial administrative or management activities of your trade or business.” These activities include:
- Billing customers
- Keeping books and records
- Setting up appointments
The dollar amount of the deduction is based on the percentage of your home that is used for business.
Assume, for example, that the portion of your home used for business purposes is a 400 square-foot room. If your office space is 15% of the home’s total square footage, you would deduct 15% of the home-related expenses.
Publication 587 provides three common home office situations:
Home office examples
Consider whether these examples apply to your business:
- A self-employed plumber spends most of his time at client locations. He uses a home office to handle billing, accounting and setting up appointments.
- A self-employed salesperson uses a home office to set up appointments, write up orders and compile management reports. He sometimes does administrative work while traveling, but most of the tasks are performed in the home office.
- A doctor spends most of his time working at three different hospitals. One hospital provides shared office space for a group of doctors, but he uses a home office instead. He regularly uses the home office to contact patients regarding scheduling, and prepares for treatments.
Each of these self-employed workers uses a home office regularly and exclusively for business, and the home office expenses are deductible.
The expenses you incur are classified as direct or indirect.
Direct expenses are business deductions that only relate to your home office space.
As the IRS points out, the cost to paint or repair the area used for business is a direct expense. The cost is fully deductible from your company’s gross income.
Expenses incurred to maintain your home are indirect expenses. The costs are deductible based on the percentage of your home that is used for business. Indirect expenses include insurance premiums, utilities and general home repairs. If you spent $3,000 to repair your roof, the expense is indirect.
You don’t have to own a home to deduct home office expenses. Renters who are self-employed can deduct home-related expenses for income tax purposes.
Two of your largest home-related expenses may be mortgage interest and property taxes.
Mortgage interest and property taxes
A portion of the mortgage interest and real estate taxes on your home are deductible as home office expenses.
Let’s assume that these two expenses total $6,000 for the tax year, and that the business use of your home is 20% of square footage. 20% of the expense ($1,200) is posted to Form 8829 as a business expense. The remaining $4,800 is posted as a personal deduction on Schedule A.
Another expense you incur as a homeowner is depreciation.
Depreciation is an expense incurred as an asset declines in value. Buildings, including homes, are assets that decline in value over time.
Self-employed people can deduct a portion of the home’s depreciation as a home office expense. To perform the calculation, you need to know the cost of your home, the expenses incurred to make permanent home improvements and the depreciation method required for tax purposes.
Calculating the home office deduction can be time-consuming, but there are tools that make the process easier.
What to do next
Use QuickBooks® Self-Employed to track your business expenses. QuickBooks can input your data into tax software, so you can generate your tax return. You can also get help from a CPA who can help you with the depreciation calculation.
The home office deduction can lower your tax liability, but you need to file an accurate return. Use QuickBooks to save time and get the home office deduction posted correctly.
Find experts to help you, so you can focus on growing your business.