According to the Small Business Administration, half of small businesses today are operated from home. Recognizing this growing trend, the Internal Revenue Service (IRS) has created rules that allow a portion of home costs to be considered business expenses and therefore deductible from business income.
Who Can Claim these Deductions?
Most types of businesses qualify, if they use a portion of their home on an exclusive and regular basis. Examples of a qualifying business purpose include meeting with clients, cutting hair, repairing equipment, or performing administrative tasks. Storage of inventory, parts, materials, and tools also count. Administrative use is the broadest definition and can benefit many businesses, especially those who perform a service or sell products at customer locations but do their bookkeeping at home.
The exclusive rule means that the claimed space must be used entirely for business, not a blend of personal and business. A portion of a space may be used, for example, part of a basement or garage. Regular use means that business related tasks are performed there on a regular basis. In some cases, a business owner may have another office elsewhere but if the home office is used frequently, then home business tax deductions are allowed.
Costs Included in the Home Office Deduction
You can deduct a portion of mortgage interest and real estate taxes if you own your home or if you're a renter, part of your rent. The same applies with insurance, utilities, a security system, and repairs. Depreciation can also be claimed if you own a home. In the case of a fire, theft, or damage from a storm, a portion of the loss can also be considered a business expense.
Your total home office deductions are limited by your business net income, i.e. they can't cause a business loss. However, excess deductions can be carried forward to the next year and claimed then.
How to Calculate your Home Office Deduction
There are two methods—standard and simplified.
- The standard method requires you to measure the square footage of the area used for business. You will then divide that amount by the total square footage of the home to arrive at a percentage.
Actual expenses are used for the standard method so that means saving your bills and adding them up at the end of the year. You then apply the business percentage to figure out how much you can deduct.
- The simplified method involves multiplying the square footage by a set rate, $5, to determine the deduction. However, the square footage is limited to 300 square feet so the maximum deduction is $1,500. This may work well for businesses with small offices, but those who use a lot of space or have multiple businesses or purposes will probably benefit from the standard method. You can switch year to year between the standard and simplified methods depending on what works for you.
More detailed information about home business tax deductions and how to calculate them is available in IRS Publication 587.