Tax Tips for Entrepreneurs and Business Owners Part 3: The Home Office Expense Deduction

The Tax Tips for Entrepreneurs and Business Owners series continues with this third article, concentrated on the home office expense deduction. This article focuses on the importance of the home office deduction for the entrepreneur or small business owner. The below discussion includes an explanation of the home office expense deduction, the test to qualify for and available methods to claim the deduction, and some key tips.

What is the Home Office Expense Deduction and How Can My Small Business Qualify?

The home office deduction allows a small business owner or entrepreneur to reduce tax liability based on expenses related to business use of a portion of his home. To qualify, the small business owner or entrepreneur must: (1) Regularly & Exclusively Use of part of his home as his (2) Principal Place of Business.

Generally, if a business owner regularly–say a few hours per day–works in a space solely dedicated as his home office, he should meet the regular and exclusive use requirements. But, this is a facts and circumstances based test, subject to many pitfalls. For instance, assume the area you utilize as a home office also contains gym equipment that you use to exercise. This could cause you to fail the exclusive use portion of the test, and lose the home office deduction.

Usually, if a business owner or entrepreneur at least uses his home office to complete administrative or management tasks without substantially using any other fixed office to do them, he can satisfy the principal place of business element. So, salespeople, tradespeople, or professional service providers (e.g., people who do most of their income-producing activity outside the home) are normally able to meet the principal place of business test by at least doing the administrative and management duties at the home office. Again, though, this determination depends heavily on facts and circumstances. So, overall, it is essential to consult with an experienced tax lawyer to review your specific situation before claiming the home office expense deduction.

Which Office Expenses Can I Deduct Related to My Small Business?

An entrepreneur or small business owner qualifying for the home office deduction may cut his tax bill by deducting the following types of expenses:

  1. Mortgage Interest;
  2. Insurance;
  3. Utilities;
  4. Repairs; and
  5. Depreciation.

These categories of expenses are important when a taxpayer uses the regular, or actual expenses method for computing the home office deduction. But, many entrepreneurs or small business owners prefer to calculate the home office deduction using the simplified method, as the record keeping requirements are less burdensome. An explanation of the home office expense deduction methods follows.

How Can I Claim the Home Office Expense Deduction?

  1. Regular/Actual Expenses Method. This option calculates the home office expense deduction based on the proportion of square feet the business owner’s home office bears to the total square footage of the home. As an example, if the home office is 200 square feet and the total square footage of the home is 1600, the deductible portion of the home is 12.5% (200/1600). Once you identify the deduction percentage, add up the items from each category of deductible expenses (see above) and multiply that amount by the deductible percentage to compute the amount of the deduction.
  2. Simplified Method. The IRS started allowing a simplified option for the 2013 tax year forward. Under this method, the business owner can simply multiply the allowable home office square footage (up to 300 square feet) by the defined rate (for 2014, $5 per square foot) to compute the home office expense deduction. So, if an entrepreneur used 200 square feet of his home for solely business purposes during 2014, his home office deduction would be $1,000 (200 x $5).

BizAndTaxHax Tips: Importantly, assuming you utilize the regular method, if you include the depreciation on your home as a deductible expense and later sell your home at a profit, you must pay capital gains tax on the total amount of depreciation deductions you claimed. Also, it is significant to note that the amount of the home office expense deduction is limited. Your deducted home office expenses may not exceed the amount of income attributable to your business–meaning you cannot use your home expenses to create a tax loss to shelter your income. Finally, the home office expense deduction varies for certain different types of businesses or industries. So, as always, you should discuss your specific situation with a tax attorney and your accountant to obtain specific advice concerning deductible expenses for your home office.

An experienced tax lawyer can help you determine whether your home office qualifies for the home office expense deduction, and assist with keeping the required documentation to support the deduction. If you are a Columbus or Ohio entrepreneur or small business owner and need help preparing for tax return filing season and planning for the future, contact me for a free initial consultation.