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Plan and Maximize Small Business Home Office Tax Deductions

Plan and Maximize Small Business Home Office Tax Deductions

Outlined below are the basic rules of the small business home office tax deduction and the deduction’s significance. We will also explain how the business deduction impacts different areas of Form 1040.

Who Qualifies for the Home Office Deduction?

The small business owner qualifies and benefits from the home office tax deduction, not the employee. See 16 Commonly Overlooked Small Business Tax Deductions. Keep an eye too on possible Congressional relief as in IR2020-220:

  • Employees who receive a paycheck or a W-2 exclusively from an employer are not eligible for the (home office) deduction, even if they are currently working from home. This employee deduction is to eventually return, if current law remains unchanged. However, it isn’t scheduled to be back as an itemized deduction until after 2025.

If you are not an employee but in ordinary business, think of home office and tax deduction as coming together for possible savings, usually as a Form 1040, Schedule C business deduction.   

The tax rules generally reach you regardless of the geographic location of your business. See Ms. Inez discussing “Small Business Owner Taxes.”  

How to Determine the Home Office Deduction

What home office business tax deductions can we count here?  Following are examples:

  • Utilities
  • Mortgage interest
  • Repairs & maintenance
  • Depreciation or rent
  • Property taxes

Mortgage interest and property taxes are commonly deductible if the homeowner itemizes.

Allocations are generally on square footage, keeping in mind “regularly and exclusively” is a requirement. Your home office needs to be your primary place of business. An IRS agent may at times press the point of “regular” and “exclusive” use of the space claimed as yielding a tax law home office deduction.

Measuring tax depreciation begins with allocating purchase price between land and structure. When you begin to work from home, think of a home office tax deduction. But the tax rules will require part-year allocations of deductible expenses, including depreciation.

Depreciation as a home office tax deduction may eventually translate into gain should you sell the home. When the tax basis is affected by the tax deduction, you may need to keep a copy of old returns to measure the tax basis.

Answers to Questions You May Have

A home office may be in a purchased home, condo, mobile home, or apartment rental – but not a hotel rental.

It appears to be permissible to claim office use for the garage, or a portion thereof, or even a barn converted partially to an office.

The rules can sometimes require close reading. For example, the home office tax deduction can be at risk if the owner does significant management or administration at another fixed location, although such activities may be done by others. If it is a relief, the IRS does not require all administrative activities to be conducted at the home office in order to sustain a tax deduction.

Simplified Version vs. Actual Expense Deduction

The simplified method allows $5 per square foot (to the extent the home is used for business), up to 300 square feet. This translates into a maximum annual deduction of $1,500. Using the $5 per square foot method doesn’t take away from the general requirements, such as having to use the space exclusively and regularly for business.

Unless you use the simplified method, plan on keeping related receipts, even if only 10% of the expenses end up as home office business tax deductions. Does the use of the home office space to do bookkeeping qualify as exclusive business use? Yes, even when the business books involve some allocating. See Rev. Proc. 2013-13.

The simplified option is less work to obtain a small business home office tax deduction. But will the actual expense approach save more tax?

The choice of methods is available year by year. See FAQs - Simplified Method for Home Office Deduction:

  • You may elect to use either the simplified method or the standard method for any taxable year. However, once you have selected a method for a taxable year, you cannot later change to the other method for that same year.

Liberalizing the Basic Rules

There are more liberal tax rules under these circumstances:

  • When a home office is also a place for meeting patients, clients, or customers in the ordinary course of business
  • When used in connection with the taxpayer’s trade or business and the structure is appurtenant to but not attached to the home
  • Ordinary and necessary expenses of a wholesale or retail seller are allocable to space regularly used for inventory or work samples

Licensed daycare operators also benefit from special rules.

Limit on the Home Office Deduction

Tax rules do not allow business losses to be created by the home office deduction. The tax rules here get into sequencing. Home depreciation is the last deduction in a line of other deductions. See Sec. 280A(c)(5).

When the home office deduction meets its current limit, it is generally subject to carryover.

How Do I Calculate the Home Office Tax Deduction?

The taxpayer, or more likely the tax professional, adds up allowable deductions and then allocates based on square footage, with the help of Form 8829.

The deduction usually flows to Form 1040, Schedule C, line 30. If you are a farmer, the home office deduction trail is Form 1040, Schedule F, lines 32(a) through (f). The instructions to the 2021 Schedule F tell the farmer not to include Form 8829.

The home office deduction is in the business or farm net income and makes its normal way through to inclusion in taxable income, as well as self-employment income’s Schedule SE.

Having a home office can affect other areas of your tax return.

Impact on Transportation Deductions

Having a home office can impact your auto expense deduction in that driving from your principal place of business is usually the starting point for measuring business miles – if the trip is the same business. See Rev. Rul. 99-7. However, drawing the line between deductible auto miles to the next business meeting, versus nondeductible commuting, can be difficult. You may want to discuss this with your tax adviser.

Impact on the 20% of Business Income Deduction

There are many rules that affect 20% of business income deductions. See Section 199A. It is possible that your home office deduction will reduce the benefit of this income deduction. If it does, the usual income tax savings may be reduced by 20%.

Self-Employment Tax

The 20% of business income deduction doesn’t reduce the base for computing the self-employment tax. See Tax Cuts and Jobs Act, Provision 11011 Section 199A - Qualified Business Income Deduction FAQs,” Q18.

The income tax deduction for the home office appears to reduce the base for computing self-employment tax. So the home office may save income tax and self-employment tax.

Remember Substantiation

Residential property expenses, such as utility bills, can be part of your substantiation trail on the way to the small business home office deduction. Even if one uses the simplified method to combine home office and tax deduction, take care to substantiate the amount of space and regular business use.

A Small Business Owner Planning Perspective

The tax rules can be complicated when you combine home office and tax deduction. Your tax adviser can help measure and plan your small business home office deduction.

The home office deduction is one of many deductions that may be available to small business owner. For the small business owner interested in tax savings, use tax planning throughout the year to reduce your small business taxes!

Ines Zemelman, EA
Founder of TFX