A Guide to Tax Deductions for Home-Based Businesses

Maximize tax deductions for your home business

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Home businesses have some unique expenses, including costs for the space where you are doing business at home. You can save on taxes by deducting many of these expenses, so it’s important to know what they are and how much you can deduct.

Learn about a few of the most important deductions specifically for home businesses and how to claim them.

Key Takeaways

  • You may claim a deduction for your home office space if you use it regularly and exclusively for business purposes.
  • To calculate the deduction, separate business and personal space in your home and only claim the business portion of expenses.
  • There are two calculation methods: actual expenses and a simple method for smaller spaces.
  • If you use the actual expense method, you may be able to deduct driving expenses to and from your home office and depreciation on your home.

When You Can Claim Home Office Deductions

One of the most significant deductions unique to home businesses is for the cost of the rent or mortgage in proportion to the area in your home where you work. You can qualify to claim this home business space deduction if you meet the Internal Revenue Service (IRS) requirements that the space must be used regularly and exclusively for business purposes.

Regular use means that you use the space on a consistent basis, not just incidentally or occasionally. If you use the space every day to do your business, for example, that’s considered regular use.

Exclusive use is the more restrictive qualification. It means you can use the space only for business purposes and never for personal use. For example, if you have an office space in a spare bedroom, you can’t store personal items in that space or use it once in a while for guests.

If you have more than one business location (a home office and a warehouse, for example), your home office must be your principal place of business. To know if your home space is your principal place of business, consider the relative importance of what you are doing at each location and the amount of time spent at each.

You don’t have to show that you qualify for a particular home-business deduction by including documentation on your business tax return. However, you should be able to provide proof in case of a tax audit.

How To Calculate Your Home Office Deduction

You can calculate your home office deduction in one of two ways: using actual expenses or a simplified option for smaller offices. All of your home expenses must be divided between deductible business expenses and nondeductible personal expenses.

For both deduction methods, you must first calculate the square footage used for business purposes and the percentage of your home-business area within the total square footage of your home. For example, if your home is 1,500 square feet and your home office space is 150 square feet, your home office space is 10% of your total home space. Therefore, you could deduct 10% of business-related home expenses for your business.

Regular Method

The regular method of calculating deductions considers all of your home business expenses, dividing them between personal and business use. There are two kinds of expenses to consider:

  • Direct expenses: costs for the business part of your home that are deducted in full, like painting your office
  • Indirect expenses: costs based on the percentage of home use, like mortgage interest, utilities, and homeowners insurance

These calculations are complicated because there are many restrictions and qualifications. Consider getting help from a licensed tax professional if you want to use the regular method.

Simplified Method

If your home business space is 300 square feet or less, you may be able to use a simple calculation to determine your deduction. The calculation is the number of square feet for your business space times $5 per square foot. A business space of 100 square feet, for instance, would mean a deduction of $500.

You can select the method that gives you the highest deduction, but some qualifications and restrictions apply. Again, consider consulting a licensed tax professional to determine which deduction method is best for your business.

More Tax Deductions for Home Businesses

In addition to the home office space deduction, you may be able to take several other tax deductions as a home business owner.

Driving Expenses from Your Home Business

The IRS doesn’t allow business owners to deduct personal commuting expenses from home offices to business locations, but home businesses are an exception. If your home is your principal place of business, you can deduct expenses from your home to do business, like business banking, meeting customers, and picking up office supplies.

Depreciation Expenses

Depreciation is a tax strategy to spread out the cost of major business assets, taking a deduction for part of the expense over several years. If you own your home, you may be able to depreciate the part of your home used for your business, but only if you use the regular deduction method. To take this deduction, you’ll need to calculate the value of your property to figure out the amount you can deduct as an expense each year.

Claiming Home Business Deductions on Your Tax Return

Most small businesses use Schedule C to report their business income for the year. How you enter your home business deduction on this form depends on which method you use.

You can enter the calculation for the simplified deduction directly on Schedule C on line 30. To include the actual expenses, you must use IRS Form 8829, then enter the result on Schedule C.

The amount you claim for a home business space deduction is limited. You can’t deduct home business expenses greater than your gross business income to take a loss on your business taxes.

Frequently Asked Questions (FAQs)

Are there any tax deductions available for employees who work from home?

Before 2018, employees were able to deduct expenses of working from home, but the 2017 tax law eliminated this tax deduction. Most employees are no longer able to deduct unreimbursed business expenses like home office space costs on Schedule A of their personal tax returns. Only Armed Forces reservists, qualified performing artists, and some government officials can still take this deduction.

What is the difference between tax credits and tax deductions?

Both tax credits and deductions lower your tax bill, but they do so in different ways. Tax credits directly reduce your tax bill, while deductions reduce your taxable income. The IRS allows businesses to take tax credits for certain kinds of activities like making changes for disabled people. You must apply for the tax credit after you perform the activity.

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