To be considered your primary office, you home office must be your principle place of business or a place where you meet or deal with clients or customers in the normal course of your business. In addition, your home office has to be used exclusively for business; it can’t be a room where you also watch TV or pursue your hobbies.
If those criteria are met, there are a host of expenses you can deduct. The IRS offers you two ways to calculate these deductible home office expenses: simple and complicated. The simple way is to take a straight deduction of $5 per square foot up to 300 square feet of your home office.
The more complex, but often more lucrative way is to figure out the percentage of your home’s total area taken up by the home office, and then to apply that “business percentage” to the allowable expenses. So, if your home is 1,500 square feet and the office takes ups 300 square feet, you can deduct 20 percent of your allowable expenses. We’ll assume you’re a savvy businessperson who is going to take the latter route, which will entail completing IRS Form 8829, as well as making use of the following tips:
Expenses for rent and mortgage interest
Applying the business percentage, you can deduct a portion of your rent or mortgage interest payments. Mortgage interest is also available as an itemized deduction, reported on IRS Form 1040 Schedule A. You can still take the itemized deduction on Schedule A, but the value of that deduction will be offset to account for the business deductions.
Similarly, you can deduct your property taxes as an itemized deduction on Schedule A, but if you want to maximize things, you should also take the proportionate amount that correlates to your business percentage as a home office deduction, too. As with mortgage interest, the property tax deduction on Schedule A will be offset by the value of the home business deduction.
You can deduct utilities in the same way you calculate rent or mortgage interest deductions. Just total up your annual expenses for electricity, gas, and water and then multiply that amount by your business percentage.
Don’t include your telephone service here. If you have a phone line that is dedicated solely to the business, you will report it as an expense on IRS Form 1040 Schedule C (Profit or Loss from Business). And if you use your phone line for both business and personal calls, you’re out of luck in terms of deducting any of its cost.
Home improvements, repairs, and maintenance
You can also write off a portion of home repairs and improvements, provided they benefit your home office. So if you install a new furnace, air conditioning system, roof, or septic system, you can deduct a portion of the cost, again by applying the business percentage to the total expense.
You may deduct the business percentage of your homeowner’s or renter’s insurance. If you have separate business insurance, that constitutes a straight business expense and is not part of the home office deduction.
Through depreciation you can deduct a portion of the cost of your home that is used for business over time. You need to determine the home’s basis, which is the lower of the home’s fair market value when you began using it for business OR the cost of the home, plus improvements before you started doing business there. You multiply the basis by the percentage of the square footage that is used for the business. You then multiply that by a percent set by the IRS in Publication 946: How to Depreciate Property.
Home office deductions can save you money, but it’s important that you do them correctly and within the law. Taking the home office deduction is one of the flags that can trigger an audit, particularly if the deduction is large relative to the income derived from the business. That said, if you qualify, you should definitely take the deduction—Uncle Sam wouldn’t want you to overpay, now would he?