Home-Based Business Tax Deductions

In our current day and age, higher percentages of the population are finding themselves working from home, and a large percentage of those are operating a home-based business. Trends are showing that these numbers are increasing and are likely to continue to rise. With more people running their businesses from their home offices, it's important to note that special tax deductions can be taken advantage of and applied to home-based businesses. The following will discuss special home office tax deductions and what is required in order for you to maximize these deductions.

Suppose you are a business owner or independent contractor who receives income where taxes are not withdrawn upon payment (1099) and operates your business out of a home office. In that case, you may qualify for the home office deductions. If you meet the appropriate qualifications, the IRS may allow you to deduct some of your home expenses on your tax return, reducing your overall taxable income.

The following is a list of the criteria that may qualify those eligible for the home office tax deduction:

• Homeowners and renters who work from home as long as they are not filing as W-2 employees.
• A portion of your home is exclusively dedicated to the operation of your home-based business. This space would be required to be used regularly and only for your business.
• The home is the principal place of business. Although if you conduct business outside of the home but still use your home to conduct business, you still may qualify.

The home expenses you can deduct as a home-based business owner or independent contractor may include the following:

• Mortgage Interest
• Rent
• Homeowner's Insurance
• Property Taxes
• Utilities
• HOA Expenses
• Depreciation

The amount of these various home expenses that you can deduct is based on the percentage of the square footage of your home that you use for your business. So how do you calculate this deduction? There are two ways in which to calculate the home office deduction. As they say in the movies, there's a simple way or the hard way, or when it comes to the home office tax deduction, there is the simplified method and the regular method.

The simple method allows you to deduct a fixed amount (currently $5.00) per square foot of your home that is used exclusively for your business, but with a limit of 300 square feet. So, if your home office is 250 square feet, you can deduct $1,250. Unfortunately, the simple method only allows you to deduct a maximum of 300 square feet or $1,500, potentially limiting your deduction.

The regular method is a bit more involved, but it can allow you to deduct a more significant amount. The regular method accounts for situations where the space used by a home-based business may exceed the 300 square feet limit of the simple method. A "home office" is not the only business use of a home that applies to this deduction. Storage of inventory, production of goods, and so on, are uses of the home that all can qualify for this deduction. These types of utilization of space can far exceed 300 square feet. Another way to look at the regular method is you may have a 300 square foot home office, but the percentage of that square footage calculated into your home expenses is much greater than the $1,500 a year offered by the simple method. These are some reasons why taking the time to use the regular method to calculate the home office tax deduction would be worthwhile.

The regular method takes the square footage of your home dedicated to operating your business and divides it by the total square footage of your home; this finds the exact percentage of your home that you use for business. For example, if your business uses 1,000 square feet of your 3,000 square foot home, your percentage would be 33%. The regular method then takes this percentage and applies it to the total cost of your eligible home expenses used to run your home-based business. This calculation produces the number that makes up your "direct expenses" that apply to running your home-based business. These calculations using the regular method can significantly increase the amount you can deduct on your home office tax deduction.

If you meet the qualifying requirements, the home office tax deduction is a worthwhile deduction to claim on your tax return. Taking the time to calculate your home office tax deduction using the regular method (or having your CPA or accountant do it) is worth the effort as it may save you a significant amount of money by reducing your overall taxable income.

Continue reading:
Overlooked Tax Deductions for Small Businesses - Part I
Overlooked Tax Deductions for Small Businesses - Part II

Disclaimer: Incorp.com is not a law or accounting firm, and Incorp.com should not be relied upon to provide legal or tax advice. If legal or other accounting assistance is needed, we recommend that you seek the services of a competent professional. The content on Incorp.com should not serve as a substitute for legal advice from an attorney or accountant familiar with the facts and circumstances of your specific situation. Contact your tax adviser or legal counsel before making any decisions.