Lots of businesses are operated out of home offices and business gurus promote a home office as an attractive way to reduce your taxes. While the tax reduction can be attractive, it is not a well-understood deduction and too many entrepreneurs expose themselves to the risk of audit by painting everything in their home with a “business use” paintbrush. Every single year without fail, I get several questions on how the US home office deduction works. Hopefully this blog will explain it in detail, while saving you from the headaches and hassles of explaining to an auditor about how the antique armoire in your bedroom is a business expense.
Basically, the concept is this: If you have an office in your home, and if it merits a write-off for using this space for business, there are calculations that determine what is appropriate. The concept is clear enough but the trick is determining how much of a deduction.
When preparing your taxes it is very easy to calculate this by following the instructions in Publication 587, Business Use of your home, however, I will outline the basics for you.
There are 3 questions you have to answer:
- How many square feet is your home?
- How many square feet is your office?
- Is your home office your principle place of business? (If yes, this qualifies you to take the deduction, if no, you are either disqualified, or may qualify for a reduced percentage and it is best to speak with a tax accountant)
Let’s take an example:
If your home is 1,000 square feet, your office is 250 square feet, and your home office is your principle place of business, you qualify for the deduction and your business use of your home is 25% (250 square feet out of 1,000 square feet).
Since business use of your home is 25%, we next figure out your housing expenses:
- Rent or Mortgage Interest (not the whole price of the mortgage, just the Interest)
- Water, Electricity, Waste Bills
- Telephone Line (if shared with household)
- Security System
- Property Taxes, Home Owners Insurance
- Repairs & Maintenance on your home
- Cleaning Services i.e. Carpet Cleaners, Weekly Maid Service, etc.
Let’s say that you have the following:
- $12,000 annual rent
- $6,800 in annual utilities
- You do not share your home telephone line; you have your own business line which was directly written off
- $1200 in a security system annually
- You replaced all of your windows this year, for $8,000
- You have a weekly cleaning lady at $80/wk x 52 = $4,160 a year
That makes you total household expenses $32,160.00 and since you business use of home is 25%, that entitles you to a home office deduction of $8,040.00!
Things get more complicated when it is a purchased home (i.e. you have a mortgage) and you elect to use depreciation as a business expense, or when you have multiple places of business and your home office may not be your primary.
However, if you are a freelancer or consultant and you work solely out of your home – the above should guide you in keeping track of the proper expenses so that you make sure to claim your home office deduction!
A home office deduction can be an attractive way to reduce your taxes. But don’t make the all-too-common mistake of trying to write off your brand new barbecue or your daughter’s Justin Bieber poster as a business expense!