Business Use of Home
(Home Office Deduction)
Whether you use your home for business full-time or part-time, you may be able to deduct certain expenses, either as a business expense (if you have a business personally) or as an itemized deduction on your Schedule A (when you work for someone else).
If you didn’t use your home for business for the full year, you can only include expenses for the months you use your home for business.
Some expenses (I call these Step 1 Expenses and they are detailed below) are already deductible if you own your home, so you may have to run different scenarios to see if taking items as business expenses creates a bigger refund or not. Best to run a scenario where all your home-related expenses are on your Schedule A, and then a second time when you put some of them in your business expenses and a third time putting as much as possible as business expenses.
Other expenses (Step 2 Expenses – see below) are only deductible if you run a business from your home or work from home for someone else.
Your home office deduction is applied after your direct expenses (supplies, travel, cell phone, etc.). The home office deduction is limited to the net income of your business (income less direct expenses) unless you work for someone else (see note below). This is another reason to run scenarios to see what makes the best tax situation.
Also, the basic service for the first telephone is nondeductible as a business expense, but you can deduct long distance or additional phone lines (such as cell phones). This is a long-time tax regulation – I’ve seen a lot of folks have their telephone expenses reduced under examination so always a good idea to obey the tax laws.
Home office expenses are deducted on Form 8829 and that figure carries over to your Schedule C (Profit or Loss from Business) or Form 2106 (Unreimbursed Employee Business Expenses).
Please note that if you work from home for someone else (not a home-based business), your deduction isn’t limited by income and you can try to write off the expenses on your Schedule A as an itemized miscellaneous deduction.
Step 1 Expenses are home-related expenses that can also be used at Itemized Deductions (on Schedule A):
- Mortgage Interest
- Property Taxes
- Qualified Premiums for Mortgage Insurance
- Casualty Losses (above limitations)
Step 2 Expenses are other home-related expenses not normally allowed as Itemized Deductions. These costs that can be written off Pro-Rata (explained below) as business expenses and include:
- Rent (for an apartment)
- Homeowners Insurance
- Utilities (not included in direct expenses and not your basic telephone service on a first line)
- Security System
- Repairs / Maintenance
- Depreciation (limited as explained below after Pro-Rata explanation)
The Pro-Rata business use of your home is the percentage used for business divided into the total area of your home. Two common methods of calculating this percentage are:
- If the rooms in your home are about the same size, divide the number of room(s) used into the total number of rooms.
- Take the square footage of your home and divide it by the total used for business. Remember to include the square footage for a basement, attic and/or garage if those are used for business.
If you run a Day Care Facility in your home, you also have to adjust the business use percentage based upon the business percentage of time – take the total number of hours per year you run the Day Care and divide that into 8,760 (number of hours in a year). Multiply this number times the Pro-Rata business use percentage.
Once you calculate the Pro-Rata business use of your home, you should add the total Step 1 Expenses and the total Step 2 Expenses, then multiply this sum by the percentage. This will give you your initial home office deduction.
You may be able to add depreciation into this deduction. Depreciation is the write off over time (39 years by statute) the value of your home, including permanent improvements, subtracting the value of land and any unreimbursed casualty losses. You can use either the Fair Market value of the home when you first used your home for business or the initial purchase price.
So, if you buy a $200,000 home, and add $25,000 in permanent improvements, you’ve got $225,000. Say, you claim $20,000 for land, and had a $10,000 casualty loss due to a flood, you’d then subtract those items and your home would be worth $195,000. Divided by 39 years, you get $5,000 in depreciation. Multiply by your business use percentage and you have the potential depreciation you can add to the initial home office deduction.
However, you can’t take depreciation if your home office deduction is greater than your net income (income less direct expenses). Again, run different scenarios allocating costs between business expenses and other expenses you can already deduct (Step 1 Expenses).
If you have more business expenses than net income, you can carryover the unused amount to the next year.
There is an optional alternate method for calculating the Home Office Deduction beginning in 2013 – this is called the Simplified Method. You can claim $5 per square foot of business use, up to 300 square feet (so up to $1,500 dollars) and all Step 1 expenses are on your Schedule A, and there is no depreciation to calculate. However, if you determine you can have a larger deduction by doing the calculation, you can still use that method.
Here is a free client handout that will helpful – it has a couple of examples and there are a few detailed explanations for some of the categories.
I welcome your comments or questions!
Thomas C. Hodge, CPA
The Hodge Group
4118 N. Western Avenue
Chicago, IL 60618
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