Tax Planning for Small Business Owners: Home Office Deduction

The IRS allows small business owners to take a deduction for the business use of a taxpayer’s home. The home office deduction allows a taxpayer to deduct a portion of home expenses on their Schedule C or Schedule F. This tax benefit is available for both homeowners and renters, subject to the IRS guidelines below.

Qualifying for a Home Office Deduction

To qualify for this deduction, the following criteria must be met:

• The space must be the principal place of business, or used substantially and regularly to conduct business
• The use of the space cannot be merely for convenience
• Employees may not claim a home office deduction

Additionally, only certain expenses can be deducted and cannot exceed gross income minus business deductions unrelated to the business use of home, such as:

• Mortgage Interest (to the extent deductible on Schedule A)
• Real estate taxes (to the extent deductible on Schedule A)
• Insurance
• Utilities
• Repairs and Maintenance
• Depreciation
• Rent

Calculating the Tax Benefits

The IRS offers two methods for calculating the allowable deduction. A taxpayer can choose between the two methods each year, but once the method is selected for a taxable year, it cannot later be changed to the other method for that same year. The examples below illustrate the tax benefits of each method.

The Regular Method

Using this method, the expenses of operating the home (including mortgage/rent and utilities) are divided between personal and business use, to determine what percentage qualifies for the deduction. Form 8829 is used to compute this deduction (click here for additional details)

EXAMPLE

Using the regular method to determine the allowable deduction first requires calculating the percentage of office space within the home.

If the taxpayer has a 1,500 square foot home with a 150 square foot office space, the business percentage would be 10% (150 sq. ft./1,500 sq. ft.)

Then, that percentage is used to determine the amount expenses that can be deducted.

Taxpayer incurs mortgage interest at $1,200 in addition to $800 in real estate taxes:
$2,000 (total expenses) x 10% (business percentage) = $200 total expense deduction

The Simplified Method

The simplified method reduces the paperwork and recordkeeping for small businesses by setting the allowable deduction at a flat rate of $5 per square foot (max 300 sq. ft.) This method is beneficial for taxpayers who do not want to track spending related to their home expenses.

EXAMPLE

The amount of square footage used for business is multiplied by the set rate of $5/sq. ft.

The taxpayer with the 150 square foot office would receive a tax benefit of $750
(150 sq. ft. x $5 per sq. ft.)

If you would like to discuss how a home office deduction may be incorporated into your tax planning strategy, please contact your GYF Tax professional at 412-338-9300.