If you are a small business owner you have probably heard of the home office deduction. If you haven’t, the home office deduction is a tax break offered to business owners (or in some cases employees) who use a portion of their house as an office. Either way, the home office deduction is one of the most misunderstood tax deductions out there.
For those eligible to take the home office deduction, you will be able to deduct a portion of your mortgage interest, real estate taxes, utilities, homeowners insurance, general repairs, pest control, repairs to office, and depreciation is a business expense. Depending on the size of your office, this could add up to quite a large deduction.
In past years, the home office deduction required extensive record keeping. First you would need to know the square footage of your home office and the total square footage of your home. Then you would need to know the total amount of all the expenses listed above. You would also have to figure out the depreciation on the home and furniture. Finally, you would take the percentage of the home that was used as an office and multiply all those expenses by that number.
Last year, in a rare case of using common sense, the IRS simplified the home office deduction by allowing qualified businesses and employees to simply multiply the total square footage of the office by $5 to get their total deduction. So if you had a 200 sq ft office, you could take a $1,000 home office deduction. This significantly reduces the amount of record keeping necessary for those taking the deduction.
But regardless of which method you choose, you must meet certain requirements in order to take the home office deduction. First, you must use the home office for one of the following purposes:
- Your principal place of business- You have no other office, you work exclusively out of your home or you use your home office for administrative and management activities.
- A place to meet patients, clients or customers in the normal course of your business- You have to actually meet with clients in your home on a significant basis to meet this qualification.
- A separate structure that is not attached to your home- If you have a separate structure on your property that is used exclusively for business it will meet the qualification of a home office deduction. Common examples of this are studios for artists or greenhouses for florists.
- Storage for inventory or product samples- If you have a portion of your home used to store product samples or inventory, it qualifies for this deduction.
- A day care center- If you have a state licensed day care in your home you automatically qualify.
By meeting any one of those five qualifications, you may qualify for the home office deduction. But as they say in game shows “But wait, there’s more!”. Even if you meet one or more of those five qualifications, there are more rules you will have to follow.
First, the room you use as a home office cannot be used for any other purpose. This means sticking a computer in your spare bedroom will not pass this test. Second, there is an income limit attached to this deduction. You will only be allowed to deduct your home office expenses in proportion to the income earned through the use of that office. So in our example above, you would only be allowed to take that $1,000 home office deduction if you had at least $1,000 in net income.
Unfortunately, the home office is one of the tax deductions take advantage of most frequently. Because of this, it is a potential audit red flag. If you are going to take this deduction, it is important that you keep good documentation. At the very least, take pictures of your office showing that it is not being used as a part time spare bedroom, kids playroom, etc. As with any tax deduction, the more documentation you keep, the more audit proof you will be.
The home office deduction is yet another great advantage for small business owners. Follow the steps here to be sure you are taking full advantage of it.
Question: Do you currently take a home office deduction?