How Small Business Owners Can Deduct a Home Office from Their Taxes

It’s safe to say the ongoing COVID-19 pandemic of 2020 has completely altered how Americans work. Remote work is increasingly becoming the “new normal” as many business owners are abandoning commercial spaces for home-based offices. In fact, an October 2021 Gallup® poll reports that forty-five percent of full-time U.S. employees worked from home either full (25%) or part time (20%).

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If you’ve pivoted to operating your business from your home, you should consider claiming the home office deduction on your 2021 tax return. As economic uncertainty continues, saving money should be top of mind. Here’s information you need to know about this deduction.

Who qualifies for a home office deduction?

Note that if you work for a traditional employer from your home, you won't qualify for a home office deduction tax break.

Qualified taxpayers can claim the deduction whether you’re a homeowner or a renter, and you can use the deduction for any type of home where you reside. A single-family home, an apartment, a condo, or even a houseboat qualify. However, a hotel or other temporary lodging does not qualify.

The home office deduction rules also apply to freestanding structures. You can use a studio or garage space as your home office as long as the structure meets the “exclusive and regular use” IRS requirements (see below).

What conditions must be met to qualify for a home office deduction?

The IRS outlines the conditions that must be met in order to claim the home office deduction, which include:

Regular and exclusive use: You must regularly use part of your home exclusively for conducting business. For example, if you use an extra room to run your business, you can take a home office deduction for that extra room. If that room is also a bedroom, it does not count.

Principal place of business: You must be able to show that you use your home as your principal place of business. If you conduct business at a location outside of your home, but also use your home substantially and regularly to conduct business, you may qualify for a home office deduction. That means you use the space exclusively and regularly for administrative or management activities, such as billing customers, setting up appointments and keeping books and records, according to the IRS.

How to calculate the home office expense deduction

The home office deduction is calculated on Form 8829. Taxpayers who qualify may choose one of two methods to calculate their home office expense deduction:

  • The simplified option has a rate of $5 a square foot for business use of the home. The maximum size for this option is 300 square feet. The maximum deduction under this method is $1,500.
  • When using the regular method, deductions for a home office are based on the percentage of the home devoted to business use. Taxpayers who use a whole room or part of a room for conducting their business need to figure out the percentage of the home used for business activities to deduct indirect expenses. Direct expenses are deducted in full.

The expenses you may be able to deduct include mortgage interest, insurance, utilities, repairs, maintenance, depreciation, and rent. For more in-depth tax information throughout the year, subscribe to IRS Tax Tips here.

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Things to consider

Before you start the home office tax deduction process, review these points so you may be able to get the full benefit.

Receipts

If you plan on deducting actual expenses, keep detailed records of all the business expenses you think you’ll deduct, such as receipts for equipment purchases, electric bills, utility bills and repairs. If you’re ever audited by the IRS, you’ll be prepared to back up your claims.

Fear of an IRS audit

There’s lots of chatter out there about how claiming a home office deduction can trigger an audit.  However, if you regularly work from home, and if you're being reasonable and keeping track of your home expenses, there's no reason to skip it. As always, be sure to consult with a tax, or legal, expert to ensure that your tax strategy is in compliance with relevant laws and regulations.

Depreciation

If you use the actual-expenses method, you’re required to depreciate the value of your home. Depreciation refers to an income tax deduction that lets taxpayers recover the costs of property, due to wear and tear, deterioration or obsolescence of the property, according to the IRS. The depreciation you’re required to take in home office deductions is subject to capital gains tax when you sell your home. For example, if you own your home, use 20% of it as a home office and deduct depreciation, 20% of your profit on the home’s sale may be subject to capital gains tax. However, if you use the simplified method, depreciation isn't a factor and you may not be subject to the tax.

Best practices

Unless you have a background in business accounting, filing taxes correctly can be daunting. Even more importantly, you might be losing money - like from a home office deduction - without a solid professional in place. It’s a great idea to work with an accountant or another financial professional who deals with small business tax issues. Our blog post outlines the services an accountant can provide, where to search for a financial professional, and hiring best practices: How to Hire an Accountant for Your Small Business.

Final thoughts

In addition to knowing tax issues, entrepreneurs operating a home-based business need to make sure they are adequately covered by insurance. Learn the policies you might be responsible for here: What Home-Based Business Owners Need to Know About Insurance.

Ready to pivot to a home-based operation or freshen up your current home office? We asked two interior designers how a small business owner can easily create a beautiful and functional office. Lauren Webb and Josephina Serra, owners of Form Collective® in Vancouver, BC., show how to pair form with function to ensure that spaces not only look beautiful but also work to make life a little easier. Learn more here: Create a Beautiful and Functional Office for Your Small Business.

Once you’re settled in, check out these tips for work-from-home success: How to Run A Small Business from Home with Success. You’ll learn how to monitor overhead, set a schedule, and avoid isolation.

WHAT YOU NEED TO KNOW: The SmartBiz® Small Business Blog and other related communications from SmartBiz Loans® are intended to provide general information on relevant topics for managing small businesses. Be aware that this is not a comprehensive analysis of the subject matter covered and is not intended to provide specific recommendations to you or your business with respect to the matters addressed. Please consult legal and financial processionals for further information.

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