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. Since 2013, the IRS has even offered a simplified method — in addition to the regular, business percentage method — to determine the home office deduction.
Follow along as we walk you through the basics of the home office tax deduction and help you figure 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 need to determine if you’re 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.
If you’re struggling to determine your home office breakdown, think about your principal place of business. Is your entire home in regular use for business or is just one portion dedicated for exclusive use? This also includes separate structures on your property. If you build an area dedicated for work, that’s still a home office workspace and you can deduct the related business expenses.
For example, if you build a small office shed in your backyard or convert half of your garage into a dedicated office space, you can claim that exact square footage and the applicable business expenses.
Also, your home office deduction amount must not exceed your gross income after business expenses, no matter which method you choose. In other words, you can’t deduct more than you earned from the business portion of your home.
Finally, you can use either method — regular or simplified — in any taxable year, no matter which method you used in a prior year. If you used the regular method last year and want to try the simplified method this year, go for it.
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).
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.
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. You determine the deduction by figuring out the percentage of your home that you use 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, mortgage interest, utility costs, and insurance premiums to use as your home office deduction. For the right person, this can result in a larger tax deduction than the simplified method.
You may be able to 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.
When you take depreciation, you opt to have the cost of your home office structure spread out over a set period of years, rather than receive the full deduction amount all at once. This can be beneficial if you’re worried about writing off a large purchase all at once and lowering your net income drastically, as the depreciated amount will be far smaller and spread out over a period of years.
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. That means you could have to pay capital gains taxes on that appreciation gain.
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 the next year. This is a feature that isn’t possible with the simplified method.
Depending on your situation, using the regular method can result in a larger tax deduction. But it also requires more attentive record keeping and calculations. If you plan on using this method or know you have a larger home with more potential for a home office deduction, keep a mental note of your utility costs, interest payments, and any changes in your insurance premiums.
Hold onto all receipts, research additional business deductions to ensure you’re maximizing your return, and be aware of the home office expense deductions: mortgage, interest, utility costs, homeowners (or renters) insurance premiums.
Which should you choose?
Deciding whether to use the simplified method or regular method when claiming the home office deduction is tricky. You need to think about 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 comes with the regular method.
If your home office is small, you’ll likely 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. For example, those living in New York City will likely benefit more from the simplified method, versus someone living in rural Ohio.
Whatever deduction you’re looking for, 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.
Securing your home office deduction
There are a number of tax cuts available, but few are as beneficial as the home office deduction. Keep track of all your spending, think about which method will better suit you this upcoming year, and keep track of all your spending. (Did we say that twice? That’s how important it is.)
Tax season doesn’t have to be full of confusion and panic. Show next year who’s boss by prepping for your home office deduction. 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, and get the answers to common deduction questions for the self-employed.