Making your home office work with the right deduction calculation

Dustin Johnson
By Dustin Johnson
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Working from home is a major benefit for a small business owner. In addition to the cost savings of not holding a lease for the business (and expenses associated with that), business owners are able to deduct expenses for office use of their homes. 

But before measuring rooms and starting calculations, business owners should first ensure that they meet the requirements for the deduction. Namely, they should confirm two things:

  1. The part of the home must be exclusively and regularly used for a trade or business, and
  2. That part of the home must be either (1) the principal place of business; (2) a place where the taxpayer meets or deals with customers as a part of the business; or (3) a separate structure of the home used in connection with the trade or business. 

If those requirements are met, there are two methods you can use to calculate the home office deduction: the Allocation Method or the Simplified Method.

Allocation Method

In order to deduct expenses under the allocation method, business owners must first identify direct and indirect expenses. Direct expenses are those that are used for only the business part of the home and are deductible in full. Examples of direct expenses include equipping the office with office furniture. Indirect expenses are those expenses of keeping up and running the entire home. 

These expenses must be allocated (hence the “Allocation Method”) based on the percentage of the home. Examples of indirect expenses are insurance, utilities, and general home repairs. Indirect expenses of the home are generally allocated based on the square footage of the home. Indirect expenses can also be further allocated if the home business owner only uses the home office for a portion of the year.

Allocation Method Example:

Richard operates a dog-walking business out of his 1,000-square-foot home. His home includes a 100-square-foot office, which he uses exclusively for the management of his business. Since the home office represents 10% of the total square footage of his home, Richard can deduct 10% of all indirect expenses (like insurance, utilities, and general home repairs) as a home office deduction. In addition, he can also deduct any of his direct expenses, such as equipping his home office.

Deduction expenses under the allocation method can get complicated. Allowable expenses are calculated using Form 8829, Expenses for Business Use of Your Home. The Form has four parts with 44 lines. In order to aid business owners in calculating the home office deduction, the IRS has provided the Simplified Method.

Simplified Method

Taxpayers with a home office may prefer to use a simplified option to determine the deductible expense amount for business use of a home. Using the simplified method, the business owner can calculate the allowable deduction using the allowable square footage of the business by a prescribed rate. The prescribed rate is $5, and the maximum square footage is 300 square feet. Thus, this method's maximum deduction is $1,500 (300 sq. ft. x $5). 

Simplified Method Example:

Using the example of Richard above, Richard is able to deduct $500 for his home office deduction ($100 square feet x $5 prescribed rate = $500).

No matter the method, the home office deduction is a great opportunity for business owners operating businesses from their homes.

This article is prepared in order to provide general advice as to the deductibility of the home office deduction. Consider hiring an accountant or attorney knowledgeable in this area for advice geared specifically to your situation.

References:

IRS Publication 587, Business Use of Your Home

Form 8829 and Form 8829 Instructions

Dustin Johnson
By Dustin Johnson
Dustin Johnson is a Senior Tax Research Specialist at ComplYant. Prior to joining ComplYant, he spent over eleven years performing tax research at the world’s largest tax preparation company. Dustin holds a Bachelor of Business Administration and a Juris Doctor. Outside of work, Dustin enjoys biking and spending time with his family.

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