If you don’t use the home office deduction, you could end up paying more tax than necessary. The Ascent tells you how to use this deduction.
The COVID-19 pandemic has caused an avalanche of people working from home for the first time. We’ve written extensively about the issues and opportunities created by this shift here at The Ascent. The authors talked about tools for working remotely, work-from-home hacks, and strategies to protect against distractions.
All interesting things. Now it’s time to put on our gloves, grab the shovel, and dig deeper into everyone’s favorite topic: tax deductions.
We’ll go over the home office deduction and talk about who can use it, how to apply it, and how much money you can save.
Overview: What is a home office deduction?
If you own a business and work in an office or retail building that you rent or own, you can claim several deductions from taxable income. You would directly deduct rent or interest paid on debt, utilities, depreciation, insurance, repairs and maintenance.
The home office deduction allows you to take these same deductions on your tax return if you have a home-based business.
Who is eligible for the home office deduction?
Small business owners and independent contractors with home-based businesses can use the home office deduction to claim expenses against their small business taxes.
Here are the main things to keep in mind if you are considering using the home office deduction:
- The IRS home office rules state that the home must be the principal place of business. You can do business elsewhere, but most must be done at home.
- When deducting home office expenses, you can only use the part of your home that is used for the business and, it cannot be stressed enough, you cannot use this area for anything else. The best strategy is to set aside a room to use as an office and keep the door closed when you’re not working. If you have kids, put a sign on the door that says, “Monsters: Stay Away!”
Simplified deduction vs. deduction of regular expenses: which method is better?
If you have experience with the IRS, you are probably already leaning towards the simplified method. The IRS definition of regular, especially when it comes to business taxes, usually means something like 20+ pages of paperwork, months of headaches, the pawning of your firstborn, and threats. voodoo magic.
I recommend calculating your deduction both ways and then choosing the approach that allows you to deduct more. Let’s see how to calculate each.
The simplified method is just that, simple. Calculate the total square footage you use for your business, up to a maximum of 300 square feet, and multiply that by $5. That’s it. I don’t even need to create a graph on how to do this.
The best way to determine how much square footage you’re using is to dig up the appraisal the bank ordered when you bought your home. It should have a breakdown of the total square footage of the house and the size of each room. We will use the total square footage for the following method.
To use the regular method, calculate the total allowable expenses for your home, then determine the portion of those that are used for the business. If you have a 2,000 square foot house and use a 400 square foot room for the business, you would take (400 ÷ 2,000) 20% of the deductible expenses.
Use IRS Form 8829 to calculate the total deductible expenses for your home office tax. This form should be available and easy to understand in your tax software.
How to determine your home office deduction
Sarah’s blood salamanders struggled. Few people think of salamanders as good emotional support pets. So, Sarah still works in the basement of her house. Her business is a one-person LLC and she is ready to file 2019 taxes. Let’s see which method she should use.
Sarah uses more than the maximum allowed area of 300 square feet for her office, so she would take the maximum allowed simplified deduction of 300 x $5 = $1,500.
Now consider how much she could deduct using the usual method. Sarah’s household expenses are fairly typical for a home valued at around $350,000.
Amortization is calculated using the straight-line method and annual interest has been estimated based on an original loan amount of $300,000. If you plan to use the usual method, keep records (ideally receipts) of your insurance, repairs, and utility expenses for six years after you file your taxes.
Each of these expenses is detailed in the chart above. Sarah’s house is 2,200 square feet in total and she uses 500 square feet for her business. This equals 22.73% of the house total, so she could be spending 22.73% of household expenses.
Unless you are filing taxes for an independent contractor and using less than 300 square feet of your home, the Regular Method will almost always allow you to deduct more than the Simplified Method.
There is also the question of how long it takes. If the usual method probably only deducts a few hundred dollars more and you’re not religiously tracking your home’s expenses, focus on finding tax credits instead of calculating depreciation.
How about working from home for just a few months?
If you are self-employed, because you own your business, or as an independent contractor who receives a 1099 every year, use one of the methods we talked about above to take the home office deduction for time. that you used your home as your main place of business.
Unfortunately, if you are a W-2 employee working from home due to COVID-19, you are not eligible to use the deduction (unless you have a secondary agitation where you get a 1099).
Home is where the taxes are not
It’s obviously wishful thinking, but the home office tax deduction allows you to reduce your business tax burden and make working from home a little more attractive during a pandemic – as long as you set strict limits for this domain.
If you have a side hustle and have worked for 1099 payouts, consider dedicating a coin just for that job. My wife’s side hustle only took about 25 hours of work per month, but we were able to designate one room as her office and significantly reduce the tax burden of side hustle.