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Tax Strategies & Credits

Small Business Owners May Qualify for a Home Office Deduction

by
Gordon W. McNamee
on
7/22/2019
Small Business Owners May Qualify for a Home Office Deduction

As technology has improved and interest in entrepreneurship has grown, there has been an explosion in the number of small business owners who work from their home. This dynamic has led to increased use of the “home office” tax deduction, which allows space dedicated to the business within the business owner's home to be written off as an expense. In order to qualify, the space must meet certain requirements, including:

  • Being the primary place from which the business owner conducts business, or
  • Being the location where clients, customers, or patients meet with the business owner during the normal course of business, or
  • Being a separate structure used in connection with the business and not attached to the business owner's home, or
  • Being the location where the business owner stores their samples or inventory and which serves as the only, fixed location of their business, or
  • Being the location where the business owner provides day-care services.

In order to qualify, the space cannot be used for personal purposes: it must have business as its exclusive use and purpose. It also must be used regularly and continuously for that purpose, unless it is being used to store inventory.

Actual Expense vs. Simple Method for Calculating the Deduction

Taxpayers whose circumstances allow for the home-office deduction to be taken can do so on the business schedule of their self-employment tax filing, and can choose between two different accounting methods: the actual expense method (sometimes referred to as the regular method) and the simplified method. When considering which is most advantageous for you, keep in mind that there are no rules preventing you from switching between the two deductions from year-to-year.

To use the simplified method, the taxpayer calculates the number of square feet of their home that is used for the business and then deducts $5 per square foot. This method limits the area for which the deduction can be taken to a maximum of 300 square feet, thus providing a maximum deduction of $1,500. This method does not allow separate or additional deductions for expenses such as utilities, maintenance or rent, though taxpayers who itemize can continue to deduct home taxes and mortgage interest.  

The simplified method is straightforward for business owners that own just one business and operate it year-round, but for those who use space within their home to operate multiple businesses throughout the year, the maximum of 300-square feet needs to be divided and allocated between the businesses for each month of use. When a business does not operate out of the home in a given month, the usage should be calculated as zero, and the same is true if the business use in a given month was less than fifteen days.

Example: Sandra begins using 400 square feet of her home for business on July 20, 2019 and continues using the space as a home office through the end of the year. Her average monthly allowable square footage for 2019 is 125 square feet (300 x 5 months = 1,500/12 = 125).      

To use the actual-expense method (sometimes called the “regular method”), the taxpayer calculates the proportion of their home's square footage that is dedicated exclusively to the business and then prorates all of the home expenses based upon that proportion. This method not only does not limit the number of square feet that can be deducted, but can also be used for 100% of directly related costs that are specific to the operation of the business or the maintenance of the area used for the business. 

The table below indicates which home office expenses are and are not eligible to be prorated by a homeowner or renter:

Though some small business owners who operate their business out of their home believe that the actual-expense method allows them to deduct a portion of their home loan payments, this is not the case. They can, however, claim depreciation for the portion of the home that is used as a home office.

What happens to your home office deduction if you move?

How your home office deduction is handled in the event of a move is dependent upon whether you are a renter or a homeowner.

Tax law says that if you are a homeowner who sells a home that you have lived in for at least two out of the five years before the sale, you are able to exclude a significant amount of your gains from your taxes ($250,000 for those filing under single status and $500,000 for those filing as a married couple). But taxpayers who have depreciated a portion of their home that is located within the main structure of the home as a business expense since May 6, 1997 cannot exclude the amount that they have deducted in that way. When a separate structure on the same property has been used as a home office, tax law requires that the home and the home office be treated as two separate sales, leaving out the gain on the separate structure from the exclusion.

For those who take a home office deduction for a property that they rent, moving to a new location will require two calculations — one for each. If you move from a rental property that you operated your business out of to one you don’t use for business, simply calculate the expenses for the one where the business operations took place.

Other Things to Consider:

Though these rules may seem straightforward, not every situation is as simple as those described above. Some exceptions, additional comments and variations to these rules include:

  • For taxpayers who share a home and each run their business out of the home, each can take a home office deduction using the simplified method that restricts them to up to 300 square feet of space within the home. This is true regardless of filing status or the relationship between them – they can be roommates, partners or spouses — but they cannot both use the same space.

As an example, a husband and wife, if otherwise eligible and regardless of filing status, may each use the simplified method for a qualified business use of the same home, for up to 300 square feet of different portions of the home.     

  • Taxpayers who operate multiple businesses out of their home must choose either the simplified method or the actual-expense method for all of their businesses. They are permitted to switch from year to year, but not to switch from business to business within the same year.
  • The simplified method is not available for taxpayers who operate their businesses out of a home and also use it as a rental property.
  • For those who switch from using the simplified method of calculating home office deductions to the actual-expenses method and who choose to depreciate the portion of the home that is used, there is no special way of calculating the depreciation.

The Last Word on Home Office Deductions

As is so often true, the amount that you are able to deduct for your home office is not allowed to exceed the gross income that your business takes in, which for tax purposes is interpreted as the business’ gross income with the normally allowable home expenses such as property taxes, casualty losses and mortgage interest subtracted. A carryover is permitted if you’re using the actual expense method, but not for business owners who choose the $1,500 deduction provided by the simplified method.

Business owners who need more clarification on the right way to take advantage of the home-office deduction can get the answers they need by contacting a tax professional for assistance.

Gordon W. McNamee, CPA writes for TaxBuzz, a tax news and advice website. Reach him and his team at [email protected].

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Gordon W. McNamee

Gordon W. McNamee

Gordon W. McNamee is a Certified Public Accountant (CPA) based in Rancho Cucamonga, CA. Gordon W. McNamee can assist you with your tax return preparation, payroll, accounting and tax planning needs. <br /> <br /> 2021 is Gordon W. McNamee, CPAs 38th year in the profession. As as a former IRS agent (1984 through 1987), Gordon has been in public accounting since 1987. Gordon specializes in individual, corporate, HOA, trust, estate and payroll taxes. He also prepares financial statements and provides accounting & bookkeeping services. He enjoys making his clients feel at ease while providing a personalized professional service.

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