I’d bet that on just about every city block or long country road, someone is operating a business from their residence. According to the U.S. Small Business Administration, about 50 percent of businesses are home-based, with a larger percentage (60 percent) working as solopreneurs with no employees.
Having a home-based business is one of the easiest and least risky ways to become an entrepreneur, test your business ideas, and increase your income. No matter if you run a business full-time or as a side gig, claiming the home office deduction can significantly reduce your taxes.
No matter if you run a business full-time or as a side gig, claiming the home office deduction can significantly reduce your taxes.
I received an email from John, who says, “My New Year's resolution is to earn more money working during my off-hours and on weekends. Since the work will likely entail making deliveries for different mobile apps, I’m not sure if it qualifies me for the home office tax deduction. Can you explain more about it?”
Thanks for your great question, John! In this post, I’ll give an overview of the home office deduction. You’ll learn who qualifies, which expenses are deductible, and how to legitimately claim this money-saving tax break no matter what type of business you have.
Who can claim the home office tax deduction
If you work for yourself in any type of trade or business, either full- or part-time, and your primary office location is your home, you have a home business. The designation applies no matter whether you sell goods and services, are a freelancer, consultant, designer, inventor, Uber driver, or dog-walker.
If you work for yourself in any type of trade or business, either full- or part-time, and your primary office location is your home, you have a home business.
You can have a home-based business even if you’re like John and mostly earn income away from home. This is common for many trades and solopreneurs, such as musicians, sales reps, and those working in the gig economy. If you’re self-employed and do administrative work like scheduling, invoicing, communication, and recordkeeping at home, you have a home business.
Note that employees who work from home can’t claim a home office deduction. W-2 workers used to be allowed to include certain expenses if they itemized deductions. But tax reform took away that benefit starting with the 2018 tax year.
The home office deduction is available for any self-employed person no matter whether you own or rent your home, with the following two requirements:
- Your home office space is used regularly and exclusively for business
- Your home office is the principal place used for business
You must regularly use part of your home exclusively for conducting business. For example, if you use a guest room in your house or a nook in your studio apartment to run your business, you can take a home office deduction for the space.
You don’t need walls to separate your office, but it should be a distinct area within your home. The only exception to this “exclusive use” rule is when you use part of your home for business storage or as a daycare. In these situations, you can consider the entire space an office for tax purposes.
Additionally, your home must be the primary place you conduct business, even if it’s just the administrative work you do. For example, if you meet with clients or do work for customers away from home, you can still consider the area of your home used exclusively for business as your home office.
Your home doesn’t have to be the only place you work to qualify for the deduction. You might also work at a coffee shop or a co-working space from time to time.
You could also consider a separate structure at your home, such as a garage or studio, your home office if you use it regularly for business. Also, note that your home doesn’t have to be the only place you work to qualify for the deduction. You might also work at a coffee shop or a co-working space from time to time.
RELATED: How to Cut Taxes When You Work From Home
Expenses that are eligible for the home office tax deduction
If you run a business from home, two types of expenses are eligible for the home office deduction: direct expenses and indirect expenses.
Direct expenses are the costs to set up and maintain your office. For instance, if you work in a spare bedroom, you might decide to install carpet and window treatments. These expenses are 100 percent deductible, no matter the size of the office.
Indirect expenses are costs related to your office that affect your entire home. They’re partially deductible based on the size of your office as a percentage of your home.
For renters, your rent, renters insurance, and utilities are examples of indirect expenses. You’d have these expenses even if you didn’t have a home office.
For homeowners, you can't deduct the principal portion of your mortgage payment, which is the amount borrowed for the home. Instead, you’re allowed to recover a part of the cost each year through depreciation deductions, using formulas created by the IRS.
Other indirect expenses typically include mortgage interest, property taxes, home insurance, utilities, and maintenance. Allowable indirect expenses actually turn some of your personal expenses into home office business deductions, which is fantastic!
Allowable indirect expenses actually turn some of your personal expenses into home office business deductions, which is fantastic!
However, expenses that are entirely unrelated to your home office, such as remodeling in other parts of your home or gardening, are never deductible. So, your ability to deduct an expense when you’re self-employed depends on whether it benefits just your office (such as carpeting and wall paint) or your entire home (such as power and water).
Also, remember that business expenses unrelated to your home office—such as marketing, equipment, software, office supplies, and business insurance—are fully deductible no matter where you work.
How to claim the home office tax deduction
If you qualify for the home office deduction, there are two ways you can calculate it: the standard method or the simplified method.
The standard method requires you to determine the percentage of your home used for business. You divide the square footage of the area used for business by the square footage of your entire home.
For example, if your home office is 12 feet by 10 feet, that’s 120 square feet. If your entire home is 1,200 square feet, then diving 120 by 1,200 gives you a home office space that’s 10 percent of your home. That means 10 percent of the qualifying expenses of your home can be attributed to business use, and the remaining 90 percent is personal use. If your monthly power bill is $100 and 10 percent of your home qualifies for business use, you can consider $10 of the bill a business expense.
To claim the standard deduction, use Form 8829, Expenses for Business Use of Your Home, to figure out the expenses you can deduct and then file it with Schedule C, Profit or Loss From Business.
The simplified method allows you to claim $5 per square foot of your office area, up to a maximum of 300 square feet. So, that caps your deduction at $1,500 (300 square feet x $5) per year.
The simplified method truly is simple because you don’t have to do any record-keeping, just measure the space and include it on Schedule C. It works best for small home offices, while the standard method is better when your office is larger than 300 square feet. You can choose the method that gives you the biggest tax break for any year.
But no matter which method you choose to calculate a home office tax deduction, you can’t deduct more than your business’ net profit. However, you can carry them forward into future tax years.
As you can see, claiming tax deductions for your home office can be complicated. I recommend that everyone who’s self-employed use a qualified tax accountant to maximize both home office and business tax deductions.
Yes, professional advice costs money. But it’s well worth it, and it usually saves money in the long run when you know how to take advantage of every legit tax deduction.