One of the greatest attractions to running a home office is the amazing tax deduction you can earn for it. However, this deduction can be more difficult to obtain than many give it credit for. If you are not ready for the questions the IRS, and by extension your tax agent, will ask you, then you may not receive any deduction at all. Part of this is knowing what to say, and part of it is knowing how to use your home office in general. What all the questions come down to really is that the government wants to know as clearly as possible that this is a home office, not someone’s bedroom.
What are the Requirements to Deduct my Home Office?
There are effectively two requirements to deduct any cost on your home office. Is your home office for the regular and exclusive use of business? Is your home office the principal place of business?
By regular and exclusive use, the government means that you use your home office often and only use it for the business. This is proved to them by there being no one renting a room or living in the home office. Renting to a roommate for their home office also does not count as a home office. This does not mean the IRS is asking for an itinerary of what you do during your work day. They don’t care if you surf the web for cat videos when you are supposed to be productive, though your boss may.
The IRS also of course wants to make sure you use your home office often. The fact that you have a home office is irrelevant if you get all of your work done at another office five days out of the week. At that point, your home office is fairly auxiliary, and the government does not see a reason to let you off the hook over it.
What can I deduct on my Home Office?
To be concise, you can really deduct any cost you have on the home office at all. We will try to separate these out and give quick explanations on the details and checks that may get in your way.
- Construction of the Home Office
Whether you are building a shed in your backyard into a workspace, or you are converting a basement or spare room into an office, construction and renovation costs are fully deductible so long as they are relevant to the use of the home office. If your basement is being converted into a spare bedroom and a home office, for example, then you would deduct based on the percentage of the basement that the office takes up versus the spare bedroom. Sleeping in your office does not mean the government gives you money back unfortunately.
Even costs such as painting and most decorating is fully deductible if it is for the purpose of greeting clients. Any additions to the home office portion of your home are deductible. However, doing renovation on any portion of your home that is not part of the home office is not deductible. Renovating your kitchen does not count, and painting your whole home is only relevant to the percentage of the home that the office takes up.
- Tools, Furniture, and Equipment of your Home Office
Adding any furniture or work-relevant tools or equipment to your home office is also deductible. This includes a new computer or any upgrades to your electronic equipment. So long as these tools and equipment are used primarily for work at least 50% of your work duties, they will remain fully deductible. If your computer is also for personal use however, you will only be able to deduct however much of your time you spend doing business on your computer. For example, if you use it for personal use for 30% of the time, then you will only be able to deduct 70% of the cost of the computer.
Now if you are an employee of a business, the business will often be able to reimburse you for the cost and receive its own tax deduction. Of course, this would mean you do not receive the deduction. Before 2018 taxes, if you were not reimbursed by your employer for your computer purchase, you were able to deduct the expense. Unfortunately, you are no longer able to make any such deduction if you are not reimbursed for the expense.
Finally, there are a few last details. You cannot deduct the cost of this equipment such as a computer for any amount exceeding the income from your business. However, you can deduct the rest of the expenses in future years should your income continue to develop. You also could add another salary, or your spouse’s salary to make up the income amount and thus allow for the full deduction in the first year of purchase. It is important to note that the deduction cannot be made for any property such as a computer that was purchased in a year before it was used for the business. Having a computer, then opening a business and deducting expenses for the computer you have had does not warrant the government giving you money.
Can I Deduct Rent or Mortgage Payments?
Just as your employer would be able to deduct the cost of an office space for employees, you can deduct the cost of rent or mortgage for using your home office. This includes if you were to pay for renting a private office or studio to do business there. However, you of course cannot deduct the entire cost of your mortgage or rent, but you would deduct the percentage of the home or apartment that you use for business purposes. Specifically, you would deduct however much percentage of your home your home office takes up.
- Phone and Internet Bills
Just as you could deduct the cost of rent or mortgage, you could deduct the cost of really any bills that relate to your business expenses. These include your phone and internet bills. They will probably not include your TV bill unless you are a sports commentator or something related and need to watch every game. Water and trash bills will not be deductible just because you need to get a shower to go to work. Just as with the rent or mortgage again, you could not deduct the entire cost of such bills. You would only deduct a relative percentage of the bill according to the percentage of the service that your business in your home office uses.
How can I Calculate my Deduction?
As we mentioned before, many of your deductions are based on a few different percentages that are relevant to what your business in your home office uses compared to what the home as a whole uses. If your home office is a 10×10 or 100 square foot room, and your home is 1,000 square feet, then your home office takes up 10% of the home and will therefore allow for a deduction of 10% of your mortgage. This is a bit trickier for other bills such as internet, or really it is a bit more estimative. You would guess perhaps that you use your internet connection 70% of the time for work and 30% for pleasure, for example, and receive a correlating tax deduction. Keeping a careful record such as a daily itinerary will make getting this deduction approved much easier, as will keeping all related receipts. You can also take an internet deduction even if you did not deduct your home office itself. All of this is used in your 1040 tax return documents.
How do I File this Tax Return?
There are several forms, documents, sections and schedules to know about while making this tax return. We will outline a few of the vital ones here. Many tax agents can be a bit unsure and fuzzy on the details for some of these newer rules in taxes, so even if you do have one, it is so important to know these rules yourself. Having a tax agent do your taxes incorrectly will not save you from getting hit with a frightening and pricey audit as my parents recently found out.
From my own perspective, an agent one year did not know some rules that could have saved me several hundred dollars on my taxes. She actually knew the new rule that my computer could not be deducted from my taxes because its cost exceeded that of my business’ first year of income. What she did not know is that my supplementary income that I was living on while hoping my business would soon take off was usable to fulfill that deduction requirement. I found this out doing my deduction this past year, and I am trying to make a correction on that now, though I have low hopes with my small amount of retained records from that previous and disappointing tax return.
- IRS Publication 587
Publication 587 according to the IRS themselves is for figuring and claiming the deduction of the business use of your home. If you would like to read the entire publication, have at it. As with most government detailed documents, it is lengthy and cumbersome. It will help with the details on furniture, equipment, selling a home used for business, and what specific records you should keep should you have any questions we did not answer. The form also has worksheets and direction on how to use the following documents in your tax preparation.
Using part of your home for rental, daycare, storage, or for the exclusive and regular use of business or meeting of clients will qualify for the deduction. The first three categories have some extra details, and since we have gone over the requirements of the latter categories already, we will gloss over these. For storage for example, the rules are sensible and should follow the patterns we have laid out. You must the space regularly and for the product or samples you sell at wholesale or retail, and it must be the only location for such storage.
- IRS Schedule A
Schedule A is where you will file your itemized deductions for the tax season. You can deduct a lot of things as we have discussed, but there are a few changes to 2018. For example, there is no longer a total limitation on the deductions you can make between state and federal deductions, but there is a limitation of $10,000 for deductions on state and local taxes. There is no longer a miscellaneous item deduction, and there is no deduction for foreign real estate taxes. There are several other changes that are worth looking up. You can even deduct many healthcare costs, such as any exams, tests, insurance premiums, nursing or hospitalization. Conversely, items like diet food cost, cosmetic surgery, and imported drugs are all forbidden from deduction.
- IRS Schedule C
Schedule C is used to report your wages, income, expenses, and loss your small business incurred or you incurred as an employee. This is essential for LLCs, Limited Liability Companies, and for anyone has incurred some sort of loss on their business. Another thing to consider is if you have heavy highway vehicle use, you may be forced to pay a federal highway vehicle use tax.
All of these rules and regulations may seem cumbersome and difficult to work around, but it is important to remember to take things one at a time. Skipping steps can lead to you losing out on money, or potentially dealing with a frightening audit. Several of these steps on Schedule C are self-explanatory as with most tax forms. You have to put in all of your personal information. They want to know the income on the business. You can report your deducted losses and expenses as we have discussed. There is an area for other expenses, but if it is not listed above in the tax form, you should make sure with a tax professional before applying for that deduction.
- IRS Tax Form 8829
Form 8829 is for the business use of your home. This is where you will be making all deductions related to your mortgage, your home phone, your home office, and your home office equipment and tools. As you will see, the beginning of the document is in reference to how much of your home your home office takes up. This is essential for further deductions related to internet, mortgage and rent, and whatever utilities are relevant to your business.
As you get down, you will notice sections for depreciation of your home and repairs for the home office. Importantly, there is a section on carryover of unallowed expenses from the previous year, and then again to the following year. If you are deducting more expenses than your business has income, you may not be able to see everything deducted as we discussed, but you will be able to deduct those expenses in succeeding years provided the business continues to bring in income. Hopefully, the business begins to bring in income that exceeds the expenses soon. If that isn’t the case, maybe reconsider the business instead of the tax forms. If you are finding too many expenses and not enough income from your small business, consider our article on How to Make my Small Business Successful?
Tying Up the Tax Season’s Loose Ends on your Home Business
As you can see, there are several important forms and details that require some fine print reading when it comes to deducting expenses for your business, as an employee, and for your home office. It may seem easier to just wrap it all up, tie a bow on it, and send your information to a tax agent to take care of. Again, this will be no saving grace if the agent makes a mistake. They will get reprimanded, but you will get audited because there are your taxes, not the agent’s. It is vital to know what your tax deduction rights and expectations should be as someone using a home office or running a small business. It may be helpful to still have a tax agent and be inquisitive on the deductions and numbers that your agent enters so that you can continue to learn through the process. This is not to discourage using a tax agent, only to encourage education. If you have questions, the IRS goes in detail on every point, every form, and every schedule and section here.If you are not even sure if your business from home qualifies for tax deductions, well it probably does. The qualification is are your providing a good or service legally for payment. But if you need more tips of what a good home office business would be or if you are on the right path, check out our article on What Kinds of Businesses Can I Start to Work from Home?