If you are self-employed, and maybe even if you work for a company from your home, you may be able take to take a deduction on your income taxes for the business use of your home. This may reduce the taxes that you pay each year to the U.S. Treasury, which can be a fair amount of money. The caveat here is that you really must actually use a portion of your home exclusively for business, and not just as a convenience to you when you don’t feel like going into the office. Here’s a rundown of the basics on the deduction, how it applies, where to find more information, and how it impacts your taxes.
The IRS has a very clear one-pager on the general rule of the home office deduction, which you can view here. The basic premise is that you must use an area of your home exclusively for conducting business. It could be an extra bedroom, a separate office, or even a portion of an area as long as the area is regularly used for business. It must also be your principal place of business, meaning you either work there most of the time and/or you meet clients there on a regular basis.
The deduction is based off the percentage of your home that you use for business, and then you have to apportion either rent or figure out your depreciable basis if you are the homeowner.
For rent, let’s say your business use is 200 square feet of a 1,000 square foot rental home, or 20%. And let’s say your rent is $1,000 per month. In general, for the rental portion, you could take a $200 per month (or $2,400 per year) deduction, which is 20%, on your IRS 1040 Form Schedule C – Profit or Loss from Business. So your business profits would be reduced by $2,400 for the year and you’d pay less in taxes on that reduced profit amount.
If you are the homeowner, however, it gets a little more complicated. You need to figure out your tax basis (basically what you paid, plus any improvement costs), split that amount between the market value of the land and building, take the building portion and divide it by 27.5 years (per IRS rules) to get an annual depreciation amount. Then, you take the percentage of the home used for business multiplied by the annual depreciation amount and voila! — that is your home office deduction.
If you are an employee and not self-employed, there are a two more conditions that you have to meet to be allowed to take the deduction:
• Your business use must be for the convenience of your employer,
• You must not rent any part of your home to your employer and use the rented portion to perform services as an employee for that employer.
Another nice benefit if you qualify is that there are a few additional expenses you can deduct. These would be any improvements or repairs for the business, like painting or construction work, plus a portion of your insurance, utilities, general repairs, in pro-ration to the business use portion of your home. All these together can add up to large dollar value deduction and may be well worthwhile to calculate and make use of on your taxes.
There is one last item to keep in mind if you are a homeowner: down the road, when you sell the property, you may have to “recapture” the total cumulative depreciation expense that you have taken over the years. This essentially means that all those deductions you took over time may come back as income to you (“recaptured”) and will be taxable when you sell your property.
Again, any deduction should reduce your taxable income and hence reduce the taxes you pay to the IRS, and that’s the whole point of taking the home office deduction.
Either way, talk to a tax professional about all these issues to ensure you are making the correct choice for your tax situation related to the business use of your home.