The Home Office Deduction

The Home Office Deduction

If you work out of your house you should take advantage of the home office deduction, especially if you are an independent contractor. The home office deduction is available to homeowners and renters. there are two basic requirements you must meet to use this deduction:

  1. The space in your home must be used regularly and exclusively for an office.
    • If you have a room in your home that you use exclusively as an office, you qualify for this deduction.
    • If you have a room in your home that you use to meet with clients you can take this deduction.
  2. Your home must be your principle place of business.
    • If you conduct business at a location outside your house and use your home regularly for business, you can take the deduction.
    • You do all your bookkeeping and writing in an office in your home but you meet clients outside the home, you can take the deduction.
    • If You are a photographer and have a studio in your home but your business is mostly weddings, you can take the deduction.
    • When you have a separate free standing structure you use exclusively for business, this deduction applies to you.

From the IRS website – “The term “home” includes a house, apartment, condominium, mobile home, boat, or similar property which provides basic living accommodations.  It also includes structures on the property, such as an unattached garage, studio, barn, or greenhouse. However, it does not include any part of your property used exclusively as a hotel, motel, inn, or similar establishment.”



Exceptions to Exclusive Use

  • If you use the space in your home to to store inventory or product samples you do not need to meet the exclusive use test.
  • If you use your home for a daycare, you don’t need to meet the exclusive use test.

These are the only exceptions to the exclusive use rule.

Principle Place of Business

Your home office is your principle place of business if:

  • You use it exclusively and regularly for administrative or management activities required for your business.
  • You don’t have another location that you use for administrative or management activities for your business.

Administrative activities include: Billing customers or patients, Bookkeeping, ordering supplies, scheduling appointments, and writing reports. If you are a blogger and you have an office in your home where you write your posts, you can take the deduction. If you have a room or office in your house where you normally meet clients or patients, you qualify for the home office deduction. Using your home for occasional meetings, telephone calls or checking e-mails does not count. A business where you use Skype to from your home to conduct business will also qualify.



Calculating the Deduction

There are two ways to figure your deduction amount.

  1. The simplified method.
  2. Actual expenses

Simplified Method

The simplified method is call the “simplified method” because its simple. Take the square footage (up to 300 square feet) of the space you in your home for your business and multiply it by $5.00. If your home office is 100 square feet, your maximum deduction is $500. The most you can deduct using the simplified method is 300 x $5 or $1,500.

Actual Expenses

Using actual expenses to figure your deduction is not as simple as the simplified method…  To figure your deduction using actual expenses you will need to add up the expenses that can be used for the deduction. You must also know the percentage of your house that you use for your business. Some expenses are direct and some are indirect. Direct expenses are things you use only for the business use of your home. If you have a separate internet service for your office, you can deduct all of the cost because its a direct expense. The same goes for a separate land line telephone. Indirect expenses are bills you pay for your entire home such as gas and electric, mortgage interest, and insurance.

After you total your expenses you must calculate the percentage of your house that you use for your business. The easiest way to do this is take the square footage of the space you use and divide it by the total square footage of your house. So if your house is 2,000 square feet and your home office is 150 square feet, your business percentage is 2,000/150 or 7.5%. You would multiply your indirect expenses by 7.5%. If your indirect expenses are $4,000 your deduction for indirect expenses would be $4,000 x .075 or $300.

Deduction Limit

The limit for your home office deduction is based on how much net income you make in your business. If you had $10,000 in sales or other gross income and had $8,000 in expenses other than your home office deduction, then your limit is $2,000. If you you had $10,000 in sales and $9,500 in expenses before your home office deduction, then your home office deduction limit is $500. In this example if you calculate your deduction and it is $1,000, you can carry $500 to next year and use it then. Here are a couple of examples:

GROSS INCOME GROSS INCOME
      CONSULTING FEES      5,000.00       CONSULTING FEES    5,000.00
      WEB STORE SALES      5,000.00       WEB STORE SALES    5,000.00
TOTAL INCOME    10,000.00 TOTAL INCOME  10,000.00
EXPENSES EXPENSES
      WEB HOSTING        500.00       WEB HOSTING       500.00
      CELL PHONE      1,200.00       CELL PHONE    1,200.00
      ADVERTISING      2,500.00       ADVERTISING    2,500.00
      SOFTWARE      1,500.00       SOFTWARE    1,500.00
      COST OF GOODS SOLD      3,800.00       COST OF GOODS SOLD    1,800.00
TOTAL EXPENSES      9,500.00 TOTAL EXPENSES    7,500.00
NET INCOME        500.00 NET INCOME    2,500.00
HOME OFFICE DEDUCTION      1,000.00   HOME OFFICE DEDUCTION    1,000.00
TAXABLE INCOME            0.00   TAXABLE INCOME    1,500.00
CARRYOVER TO NEXT YEAR         500.00 CARRYOVER TO NEXT YEAR           0.00

There are a lot of rules for the home office deduction. But taking this deduction will save you income tax. If you are an independent contractor you will save on self employment tax as well. Remember to keep accurate records and all of your receipts and consult a CPA with any questions!



Nathan

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