Do you run your small business out of home?
If so, you may be entitled to a significant number of tax deductions that can save you a lot of money, but only if you properly track and record them. Let’s take a look at some of the most common deductions for home offices, how to track and measure them, and how you can save.
How Are Deduction Measured?
Before we get into the specific expenses that can be deducted, just a quick note on how home office expenses are measured.
In many cases, an expense can be 100% deductible if it’s entirely for business purposes. For example, if you purchase a new computer for your office that will be used for business only, the computer would be 100% deductible (assuming it’s below the $2500 limit for expensing rather than capitalizing and depreciating your computer over its lifetime). These items are measured like any other business expense, regardless of the fact that you work from home.
Other items are a bit more complex. Things like utilities can be deductible, but only the percentage that’s used for business. To measure this, you need to know what percentage of your home is used as a dedicated business space. You’ll use that percentage to calculate how much of your split-use expenses are deductible from your income taxes. Let’s look at a quick example of this:
If you have a 2,000 sq ft home and use a 200 sq ft office to run your business, you’ll be able to deduct 10% of these expenses for business use and the remaining 90% will be considered personal expenses. The IRS requires your business space to be exclusive, so a room that doubles as your living space can’t be counted as deductible office space.
To simplify reporting and save everyone some time, the IRS allows a simplified method with a little less tracking. You can use a flat rate ($5 per sq ft up to a limit of 300 sq ft for the 2020 tax year) multiplied by the size of your office space. This means you don’t need to track exactly how much you spend, just measure and multiply.
Now for the fun part! Here’s a list of the most common home office expenses you can deduct:
- mortgage interest
- home insurance
- phone service
All of these expenses can be deducted according to the percentage of use rules. Remember that the space must be exclusively used for business, however, it doesn’t necessarily need to be your only place of business. For example, if you have an outside office as well but use a home office to conduct in-person client meetings or do admin work, you can still deduct your home office expenses.
In order to claim home office expenses, your home office needs to be 1) your principal place of business, 2) a place to meet clients or customers, or 3) a separate detached structure on your property (like a shop or office in a detached garage).
In fact, there’s a hidden bonus deduction involved for those who have a home office as well as a secondary work location elsewhere. So long as your home office is your primary place of business, you can deduct the travel to your second work location as business mileage, even though traveling to work is normally non-deductible commuting expenses (just a little silver lining for you).
It’s a good idea to do a quick estimate to decide how you want to measure your expenses. Once you know you qualify for home office deductions with the above three tests (principal place of business, meeting clients, or separate structure) you’ll want to know how to get the biggest possible deduction. While the simplified method is, well, simple, it can also be limiting. The current cap is $1500, which may not be as big as your actual expenses would warrant.
To get a quick estimate, multiply your monthly total for the expenses we listed above (mortgage interest, utilities, etc.), by the percentage of business use space in your home. Multiply that by twelve to annualize and if you find that it’s substantially more than the $1500 limit, you’ll benefit from tracking and calculating the regular method.
Contact Our Office
If you are looking for more information, then please reach out to our office. Leave the tax questions to the professionals by calling our office at (314) – 260 – 7808. We look forward to hearing from you.