Home Office Tax Deduction: The Basics

Claim a home office tax deduction for the space used for your business.

If you own a home business, one of the tax deductions you are eligible for is the home office tax deduction. The IRS terms this business use of your home. You can deduct the costs associated with your business in your home office. However, it's important to be careful about how you go about taking your deduction.

What's Eligible as a Home Office Tax Deduction?

You first need to figure out whether your space qualifies as business use of your home. For the most part, this is fairly easy to figure out. If you use the area only for activities related to running your home business, then it's tax deductible.

But you have to be careful. I have a room in my home that we call my “office.” However, a good portion of the room is used for storage or for other purposes. As a result, the only part of that room I am comfortable considering a true “home office” for tax deduction purposes is the area encompassing my desk and the all-in-one printer on its stand.

One of the great things about the home office tax deduction is that you don't need an entire room to take it. You can deduct that if you do your work in a dedicated 4 x 6 area. (Sorry, there are no deductions for the couch you sit on with your laptop.)

As long as you devote an area in your home completely to your home business, you can deduct that square footage. Add it up, and figure out the percentage of your home it occupies. In our 4 x 6 example, the home office takes up 24 square feet. If your home has 1,500 square feet, you figure the percentage thus: 24/1500 = 0.016, or 1.6%.

Deducting a Percentage of Your Housing Costs

You can deduct some of your housing costs now that you know your percentage. Deduct 1.6% of your mortgage payment or rent payment. If you pay $1,100 monthly for your mortgage, that's $17.60 a month or $211.20 a year. You can also deduct a percentage of your power bill and heating bill for the year. It's possible to deduct a portion of your property taxes, interest, homeowners insurance, HOA fees, and other similar costs. Just ensure the percentage you deduct matches the percentage of your home that the home office occupies.

You do have to be aware of a few things, though. First of all, you can't deduct more than your home business makes in a year. Your home office deductions are capped so that you can't use the loss as a tax shelter. Also, in some cases for those who itemize, your home office tax deduction might be a factor related to triggering the AMT. Run a couple of scenarios to ensure you don't end up paying more because of the AMT.

Finally, be aware of the rules involved in home depreciation. While you can include home depreciation as part of your home office tax deduction, be aware that selling your home at a profit can trigger capital gains taxes on the total amount of your depreciation deductions. (If you sell at a loss, don't worry about capital gains.)

Using the Simplified Home Office Tax Deduction

Another option is the simplified home office tax deduction. The IRS will allow you to deduct $5 for every square foot of office space up to 300 square feet. In the 4 x 6 example of 24 square feet, the total is $124. As you can see, the deduction is better with the percentage method.

However, there are limitations to the simplified method. There's no ability to claim depreciation, and you won't get to recapture depreciation when you sell the home. Before you decide which method to choose, carefully consider your situation and consult with a tax professional. The IRS changes its rules regularly, so it's important to stay updated and double-check the rules.

Bottom Line

For some home business owners, claiming a deduction for the business use of a home makes sense. It can lower your taxable income and save you money. However, you must make sure you claim your deduction properly. Thanks to the rise in home businesses over the last decade, the IRS isn't especially likely to audit you over a home office claim. But, if you are audited, you want to ensure you've done everything properly and documented your expenses appropriately.

Image source: Sean MacEntee via Flickr

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