Tax Deductions for Business Use of Your Home

office-work-1149087_640Working from home. For some it’s a dream come true. The ability to go to work without having to contend with morning and evening traffic on a soul-crushing commute back and forth five days a week. Not to mention avoiding strange and annoying co-workers who may serve to hinder instead of help you get your work done each day and a boss who’s riding you from the minute you enter the office.

Working from home often means that you are your own boss.  When you’re the only one you need to report to on a daily basis, you know that you’re working for someone you can trust.

That also means you’re the one taking on the majority of the responsibilities, you’re calling all the shots, and the success or failure of the business rests squarely on your shoulders. That can be a lot of pressure for many folks but it still beats having to listen to Carol from accounting drone on and on about the office gossip while you toil away in a cubicle for someone else’s dreams and aspirations.

In short, working at home means working for yourself.  While there are plenty of pitfalls that come with owning your own business, it also comes with some pretty meaty tax deductions that you can claim when April 15th rolls around.

Since the future of the business is in your hands, the costs of running the operation will also fall upon you. Those expenses can and will add up pretty fast. Fortunately, the federal government extends a variety of tax deductions for those business owners and employees who utilize some portion of their home as a base of operations.

Don’t run off just yet and start claiming home office deductions simply because you work well into the night and tap away on a laptop while you’re having dinner and watching TV.  You need to know that there are some hard and fast rules set forth by the IRS to define what constitutes proper fair business use of your home. The tax code has established a list of qualifying factors that must be met before you can start claiming these types of deductions.

Taking a home office deduction is typically intended for self-employed individuals.  However, it also extends to employees who have solid proof that working from home is done as per their employer for the benefit of the company. One of the biggest obstacles to calculating the proper deductions has been the need for impeccable record-keeping skills.

Since the possibility of an audit is greater for those individuals claiming home office deductions, proper and thorough support backing up the right to those deductions is critical. It can also be very draining and difficult for taxpayers to maintain meticulous files to have on hand in the event the government contests their claims.

The IRS has given these individuals some options when it comes to qualifying for a deduction. The agency recently implemented a new procedure that puts less of an importance on keeping careful and detailed records of every expenditure.  The new, uncomplicated “safe-harbor” procedure is now available for claiming the deductions that individuals feel they are entitled.

Naturally, there’s a catch.  The safe-harbor procedure only provides deductions with a limit of $1,500. If you feel you have a right to claim more than that sum, then you’re still going to need to be able to provide comprehensive proof of your claims so that you can take a higher amount of deductions.

Every individual’s situation is different.  You may not have a right to as many deductions, in which case the $1,500 safe-harbor approach may be perfect for you. Conversely, you could qualify for a whole list of deductions that far exceeds the $1,500 limit throughout the course of the year and therefore you’ll want to pursue more of them.

The Rules Under Section 280a (c)

This is the portion of the tax code that establishes the qualifying requirements for home office eligibility. First and foremost, you must have a space in your home dedicated solely to the operation of a business on a routine basis.

Most individuals have an office space set aside from the rest of their home which would qualify under the tax code. It does not necessarily need to be an entire room, so don’t feel as if you have to convert one of your bedrooms into a home office. You can have an office set up in the den or some corner of a living room.  You just have to make sure, and be able to prove, that the area isn’t used for other purposes.

For instance, your “home office” can’t be your couch and coffee table situated in front of the big screen TV. It has to be an area exclusive for you to work and isn’t intended for some other additional use. If this is not the case, then you won’t be able to take a deduction.

There are some exceptions, however, such as if you operate a daycare facility out of your home or if your home is being utilized for storage of product inventory and/or samples. If either one of these applies to your situation, then you have satisfied the requirements under the code as you no longer need to meet the obligations for exclusive use.

If you have a separate dwelling on your property that acts as your place of business, you’re going to find it much easier to claim the applicable deductions for home office use. These can include anything like an unattached garage that you’ve turned into an office, a barn or large shed, even a studio off-set from the rest of the property. Demonstrating that you own one of these types of properties and conduct business from within that dwelling will be the simplest way to become eligible as per Section 280a (c).

If you don’t have something like this and your home office space is contained within the home itself, then you will be dealing with some tougher requirements for eligibility. First of all, you must establish that this space is your “principal place of business”.  In other words, it is a location where you conduct administrative and/or management duties in the operation of your company, meet with clients, and perform any other activities that are germane and necessary to the type of business you run.

You must also prove that this is the main hub of your business and that you don’t perform these business-related tasks in another location. You are welcome to have another office in addition to the one you maintain inside of your home.  However, the large majority of the administrative and management operations that are conducted must take place in the home location otherwise it will not qualify as a home office for tax purposes.

You do not have to be self-employed to claim home office deductions, but you do have a tougher hill to climb with respect to qualifications. An employee must be able to prove that they are using the dedicated home office area for the benefit and advantage of the company that they are employed by and not their own.

That employee may also qualify if they are renting out that portion of their home to an employer, which then must be claimed as an unreimbursed business expenditure on their Schedule A. This would then trigger the 2% rule, which means you are required to calculate all of your business expenses and subtract that number from 2% of your adjusted-gross-income (AGI). If there is a significant difference left over, that amount may be claimed as a deduction.

Claiming Expenses

Now that you’ve been apprised of the basic IRS requirements that must be met in order to qualify for home office use under Section 280a (c), you can determine whether or not you are eligible to start claiming your expenses as tax deductions for business use of your home. In the event that you do meet the requirements, then you are welcome to deduct a litany of expenses, both direct and indirect.

Direct vs. Indirect Expenses

Both direct and indirect expenses are eligible for deduction as per the IRS.  However, you need to know which ones you are claiming to ensure that each expenditure meets the standards for qualification under the tax code.

For direct expenses, these are costs that are paid by you that relate just to the established business area of the home. Therefore, if you paid to have ONLY that area painted or repaired or you paid for some other service that was conducted in that portion of the home, that would be considered a direct expense.

The IRS considers an indirect expense any cost paid that benefits the entire home, including the area you designated as your home office space. These are typically expenditures made to cover utilities, insurance premiums, security alarm systems, rental fees, and any repairs or improvements made to the entire property.

However, if a payment was made to cover one of the costs exclusively for the home office space, then that would fall under a direct expense. For example, if you have a separate dwelling that has its own alarm system, aside from the one that is in place for your home, then the expenditures associated with maintaining that system would be a direct expense since it is not intended to safeguard the rest of your home. It only works to protect your office.

Claiming Deductions for Business Use of Your Home

Now let’s get to the good stuff. Most of these deductions are pretty common that nearly anyone who qualifies under the home office use requirements under Section 280a(c) should be able to claim. When in doubt about your particular situation, don’t guess. Always talk to your tax professional and ask if you qualify for any of these deductions before you claim them on your return. That is the best way to avoid penalties and other fees that might come from turning in an incorrect form.

Home Office Expenses

We’ve already discussed what makes your home office a qualifying expense and the requirements that must be met. We have not yet covered how much you can deduct and how to calculate that amount. With the new updates to the tax law that came in 2014, determining the percentage of your home that is being utilized as a home office space could get pretty confusing.

It’s much easier now as the law states that you may claim $5 for every square foot of your designated area, up to a maximum of 300 square feet. The highest deduction the IRS allows would be $1,500.  However, if your space is smaller, let’s say 200 square feet, than you would multiply that times five to get $1,000 for your deduction. This is in addition to any repair or improvement costs that were incurred within the square footage of your designated office area.

Utility Expenses

The utility expense deduction relates to direct or indirect expenses that you are making to maintain the office space within your home. If these are direct expenditures (in that these utility costs are being made solely for the services within the area itself and NOT for the rest of the home), then they may be claimed in full. Again, this is typically only applicable if your office is in a free-standing structure separate from your home yet still on your property.

If your home office space is located within the walls of your home, you may then deduct a portion of the utility bills that you are paying. For this instance, you would be able to claim the percentage of the square footage that defines your office space area as a deduction. This goes for all of your major services like electric, gas/heating, and even Wi-fi.  Remember, though, since these are all being utilized during non-work activities inside the home you must be careful about how much of a deduction you are claiming; otherwise you could face an audit.

Office Upgrades

These costs aren’t just related to repainting or repairing your home office area.  You can take a deduction for home office upgrades if you incur any expenses made for new office furniture like a desk or a chair, a bookcase, filing cabinets, a wastepaper basket, or a lamp, among other items. Each of these would be tax-deductible, just as long as you’re not claiming you spent $500 on that wastepaper basket.

In short, you better have a receipt for that extravagant expenditure and even then you may not be able to deduct that cost in full. The same goes for decorations such as pricey artwork or other costly adornments. Unless you can prove that you often meet clients in your home office, you could have a tough time claiming a deduction for those types of expenditures.

When claiming an office upgrade deduction, you have a choice as to how you wish to do so. You may either take the full lump sum at once for the year the cost was incurred or take smaller equal deductions over an extended period of time. These would fall under depreciation deductions and some expenses would qualify for this method more appropriately than the alternative.

Computer devices. Mobile phone, laptop, printer, camera and tablet pc.Office Supply Costs

If you’re going to claim your home office as a deduction, then you would think that you should be able to claim all of the supplies you need to stock up that office. You’re in luck, you can!

That means you may claim the expenses on everything from printer paper, ink toner, the printer machine itself, and even things like postage (which can get pricey if your home business requires you to visit the post office on a regular basis) and the small stuff like pens and paperclips. The deduction also qualifies for high ticket items like a computer, laptop, or tablet, but only in full if you use it solely for work. Chances are that is not really the case as you likely use it for personal activities as well.  In that case, you can expense a portion of the cost.

Establishing Your Business

If you work for yourself, then you’ve probably incorporated in some capacity through an LLC or S-corp. This is done to help you alleviate those self-employment taxes you may be required to pay on your income. When you file as a S-corp, you can then pay yourself as an employee.  This amount might be less than the full lump sum you make every year (which is taxable under self-employment) and the rest of that money counts as a distribution from overall profit (which is not taxable under self-employment).

In the end, it’s the same amount of income coming in but only some of it is taxable under certain laws. It’s a way to keep more money in your pocket.

Travel Expenses

You work from a home-based office, but that doesn’t mean you won’t have to go on a few business trips every now and then. Perhaps you had to attend a convention or fly somewhere to meet with clients or investors. If you’re not getting reimbursements on these expenses, then you can take the deductions on these costs.

These deductions can include any transportation expenditures such as airfare, rental car, parking at the airport, even bus fare and taxi or Uber costs. If you had to stay in a hotel, those costs are also tax-deductible even if you had to rent a room over the weekend starting on a Friday and ending on Tuesday. The weekend is covered, even if you didn’t conduct only business on the trip. The same goes for food, but you can only claim 50% of your costs in that department.

business-lunch-handshakeEntertaining Clients

You may need to take a client to lunch or dinner. The good news is that you can claim a portion of the costs that come with doing so. Just be cognizant of what might raise a red flag with the IRS.

First of all, like any food-related business expense you may only claim 50% of the cost of the meal. Also, don’t expect to order a $2500 bottle of wine and claim that as a reasonable business expense. Anything that appears overly extravagant is likely to get you a big fat audit.

Be sure you keep your receipts and mark them accordingly when you are taking a client out for a meal to discuss business. It’ll be much easier to support your claims when it’s time to file your return.

Business-Related Commuting

You’re going to have a tough time claiming a deduction that involves a daily commute if you are taking deductions for maintaining a home office. Therefore, don’t plan on trying to claim any tax-deductible expenses that involve your automobile.

Unless, of course, those trips are being made to meet with clients or in the service of performing normal business activities related to your line of work that require you to travel in your car. It really doesn’t matter where you’re going, as long as it has something to do with your home-based company.

If you’re going to Office Depot to pick up office supplies, that would qualify. The typical deductions include the standard mileage deduction, fares for public transit use, if you take an Uber from one place to another, even parking and toll costs you may incur in your travels.

Our Final Thoughts

These are just some of the common deductions you can expect to claim should you meet all the requirements of the tax law. There are others that include your expenses for health insurance and even any money you may put away for retirement in a tax-deferred plan.

Be sure to discuss all of your options with a tax adviser, not just to make sure you’ve claimed everything to which you are eligible but also to confirm that you’ve made the proper calculations to support your claims. In addition, unless you’re taking the safe-harbor method for your deductions, keep all of your corresponding receipts and other necessary paperwork that supports everything you’ve claimed on your return. It sounds like a pain in the neck now, but it’s much easier than dealing with a full scale audit down the road.

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