How To Deduct Home Office Expenses

Working from home has many advantages, one of which being the ability to deduct certain expenses on your tax return. Many people either overlook this deduction or decide not to take it for fear of causing a problem with the IRS. Others are intimidated by the record-keeping. If you think you may be entitled to the home office expense deduction, follow the steps below, answer the questions, and calculate your tax savings! If at any point you are uncertain whether or not a particular expense is allowable, either use the provided reference sources or consult your local tax advisor.

  1. Are you eligible? Determine whether you satisfy the basic IRS requirements for this deduction by answering the following questions:
    • Is the use of your home for the convenience of your employer, and not simply helpful? Typically, if you have no actual regular office space provided by your employer, you meet this requirement. However, if your employer provides you with regular workspace, and you only work at home nights, weekends, or when the weather is bad, you do not qualify for this deduction.
    • Is there an area that you use regularly and exclusively for business purposes? In other words, is it your primary place for doing business for any trade, or a place to meet with clients or customers in the normal course of business? Is it an area not used for any other purpose?
    • Do you file a Schedule C (for reporting income from self-employment) or a Schedule A (itemized deductions)?

    If you answered "yes" to these questions, you may take the deduction. In order to do so, you will need to complete IRS form number 8829. Use the following steps to determine the actual allowable amount of expenses.

  2. Indirect Expenses. An indirect expense is one that affects the cost of running your business, even if it is not necessarily incurred as a direct result of running your business. Examples of indirect expenses for a home office include mortgage interest, real estate taxes, homeowners insurance, water, heat, electricity and waste removal. Obviously, you cannot deduct the full amount of your living expenses, but you can deduct the portion related to your home office. In order to figure out how much is allowed, perform the following calculations:
    • Calculate the percentage of your home used exclusively and regularly for business. There are two ways to make this calculation:
      • Take the square footage of the office space (length multiplied by width) and divide it by the total square footage of the house. For example, if your home office is 12' x 15', Man busy working at homeor 180 square feet, and your home is 1200 square feet, the business use percentage is 180/1200, or 15%.
      • If the rooms in your house are roughly the same size, divide the number of rooms used for business by the total number of rooms.
    • Now that you know the business use percentage, you will apply it your indirect costs. Take the total dollar amount for each of your indirect expenses and multiply it by your business use percentage. Follow the line-by-line instructions on Form 8829 to be sure you put them in the right place.
  3. Direct expenses. A direct expense in one that is incurred as a result of running a business in your home. These might include a second phone line, a fax line, office supplies, or repairs and maintenance specifically for the business space. Put these on the 8829 per the instructions. Keep in mind that many of them fall under the heading "other." Keep a breakdown for yourself, and add them together when putting them on the form.
  4. Records. Keeping good records is an important part of running a business, and clearly written records are very important to the IRS. Thanks to modern technology, this task does not have to be tedious and time-consuming. Even someone with minimal organizational skills can keep accurate records. Any of the following systems will provide you with the kind of paper trail necessary to support your deductions.
    • Traditional ledger style: You can typically find these at office supply stores. Most are broken down by month and provide columns for recording income and expenses. If you have a bill, such as a utility bill, that goes from mid-month to mind-month, don't make yourself crazy trying to allocate. The IRS is only interested in when the bill was paid, so record it in the month in which you paid it.
    • Simple spreadsheet: If you are comfortable with using basic office programs, you can create a simple record-keeping system tailored to your particular kind of business, and then adjust it as needed.
    • Commercial bookkeeping systems: Again, available at office supply stores. If you are purchasing a new computer for use in your business, you may opt to have software of this nature installed before shipping.
    • Regarding backup documentation, canceled checks and receipts are your best bet. Once an expense is recorded, you can put the proof in a file or even a large envelope. If you find you are missing anything, you can usually go online and print out a year-end statement or request one by mail.
    • Remember: you should keep copies of the return and all backup documents for at least three years from the date of filing.
  5. Other considerations. There are special rules and additional deductions for certain types of businesses, noted below.
    • Depreciation: For those who have to purchase a lot of equipment for their home office, depreciation can provide a valuable deduction. However, the related laws and formulas are fairly complicated. If you feel depreciation would be helpful, your best bet is to talk to a tax professional.
    • Daycare providers: People who provide childcare in their home have some different allowances and deductions. Consult IRS Publication 587 (link below) to see what applies to you.
    • Loss carryover: In some situations, you may carry certain business losses from year to year. See IRS Publication 587 for details.

 

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