In recent years, technology has made it easier than ever to conduct business from the home. Whether you telecommute or run your own business out of the house, you can deduct your home office costs to lower your taxes. Beginning in tax year 2013, the IRS even offers a simplified method of determining the home office deduction.
Follow along as we walk you through the basics of the home office tax deduction, and find out which method works best for your home business.
Before You Claim a Home Office Tax Deduction
Prior to claiming a home office deduction, you must determine if you are eligible. Whether you use the simplified method or take the regular approach, you can only deduct the portion of your home used exclusively for business purposes. If you use half of your home office to store holiday decorations, you can only claim half the square footage in your office.
Additionally, your home office deduction amount must not exceed your gross income from the business use of your home after business expenses, no matter which method you choose.
Finally, you can use either method in any taxable year, no matter which method you used in a prior year.
What Is the Simplified Method?
The simplified method for determining the home office deduction is fairly straightforward: You receive a standard deduction of $5 per square foot, up to 300 square feet (the deduction can’t exceed $1,500). You can still claim this deduction on Schedule A if you itemize.
When you use the simplified method, you can’t take a depreciation deduction on your home, but you also don’t have to worry about the recapture of depreciation when you sell your home for a profit.
Choosing the Regular Method
Someone with a larger home office and higher expenses might benefit from sticking with the regular method of determining the home office deduction. With the regular method, there is no limit on the amount of office space used for business. You determine the deduction by figuring out the percentage of your home used for business.
Claiming your home office deduction using the regular method doesn’t stop at the home itself. You can use your business use calculation to determine how much of the following can be deducted for business use as well:
- Mortgage (or rent) payment
- Utility costs
- Homeowners (or renters) insurance premiums
For example, if your home is 2,500 square feet and your home office is 400 square feet, you use 16% of your home for business. You are allowed to add up 16% of your housing payments, utility costs and insurance premiums to use as your home office deduction.
You can divide up your home-related deductions between Schedule A and a business Schedule C or Schedule F, whichever you use. It’s also possible to deduct a portion of the home’s depreciation when you use the regular method. Although if your home has appreciated by the time you sell, some of the deduction will be recaptured, meaning the IRS will view the gain as ordinary income.
If your deduction amount is larger than your gross income from the business use of your home, it’s possible to carry the excess amount to the next year. So if your deduction comes to $3,500, but your gross income from the use of your home amounts to $3,000, you can’t claim that “extra” $500, but you can carry it over to next year. This is a feature that isn’t possible with the simplified method.
Using the regular method can result in a larger tax deduction depending on your situation, but it also requires more attentive record keeping and calculation.
Which Should You Choose?
Deciding whether to use the simplified method or regular method when claiming the home office deduction depends on the size of your home office and the calculations you want to make. For some small business owners, the difference in the deduction isn’t worth the extra paperwork and record keeping that come with the regular method.
If your home office is small, you are likely to benefit from the simplified method. The calculations are less complex, and you’re likely to see a slightly larger deduction by claiming $5 per square foot. An exception might be if you live in a high-cost area where mortgage and rent payments are higher. Even a small home office can result in a higher deduction when your housing and utility payments are costly. A percentage of that high cost could be a worthwhile deduction.
Whatever deduction you’re looking for, whether it’s a home office deduction or the standard mileage rate for your car, run the numbers to see which method would benefit you most. If the paperwork becomes too burdensome, expense-tracking software like QuickBooks Self-Employed can help you perform the calculations and make the right decision for you.
For more tips on reducing your self-employed tax burden, check out our complete guide to self-employed deductions. Find out about commonly overlooked deductions, as well as answers to common self-employed deduction questions.