Home Office Deductions – The Ins and Outs for Small Business Owners
Home office deductions made easy
After 2020, “working from home” or, to use a more professional spin, “working remotely,” became the norm.
The new remote work environment means kids and pets pop up in work calls, we have the ability to put co-workers on mute (love this part), and attend business meetings with a “pants optional” dress code.
Many ecommerce business owners have long ago perfected the concept of working remotely. This new norm has increased the importance of making sure you can claim a home office tax deduction for your small business.
You are probably thinking “wait, are you telling me I get to work in my pajamas and get a tax benefit for it?” Yes, that is precisely what I’m telling you.
But there are certain stipulations. Let’s start with the basics.
Set yourself up for success
Let’s say you set up a nice home office where you sell your products on Shopify or Amazon.
Now, as an astute small business owner who doesn't enjoy paying taxes, you want to know if you can get a tax benefit for your home office expenses.
Can I qualify for a home office deduction?
In order to qualify for a tax deduction your home office needs to be regularly and exclusively used for business.
This means the specific area of your home must generally be used only for your trade or business.
For example, if your home office space is also used as a playroom, you may be ineligible. If, however, you set up a desk in a corner of an open space room and the rest of the room is used for other purposes, you can still qualify.
Your home office must also be your principal place of business (compared to any other work location in terms of importance of activities performed and amount of time spent at each place).
How do I calculate my home office deduction?
There are two options for you to think about:
1. The Simplified Method
The first is the simple and straightforward method that won’t require you to record and document every single expense.
Due to its simplicity, the IRS has creatively called this option the “Simplified Method” (who says accountants aren’t creative?).
To use this method, you just need to know the area (in square feet) of your home office. You are allowed a deduction of $5 per square foot (with a maximum of 300 square feet, or a $1,500 deduction).
Sounds pretty easy right? Well, it can be but there is always fine print. The Simplified Method cannot be used for employees. This is important because it means it’s available only to business owners (i.e., sole proprietors/ owners of single-member LLCs or potentially partners in a partnership).
2. The Regular Method
The second method is based on actual expenses and, shockingly, is not as simple as the simplified method.
In order to calculate the deduction for actual home office expenses, you will need to first determine if the expenses are direct, indirect, or unrelated.
Direct expenses, such as a renovation of a basement to be used as a home office, is generally 100% deductible.
Indirect expenses (such as rent or home mortgage interest, property taxes, depreciation, utilities, etc.) are deductible based on the percentage of the area of your office space over the total area of the home (or based on the number of rooms in your home if they are all relatively the same size).
For example, if your home office makes up 10% of the area of your home, you can generally deduct 10% of your indirect expenses. To get a better understanding, you can look at Form 8829.
Form 8829 is used by sole proprietors or owners of a single-member LLC to claim a deduction on Schedule C of their Form 1040 (Individual tax return) but this form can also be helpful to other taxpayers to help them determine and substantiate their actual expenses.
Unrelated expenses are generally not tax-deductible. For example, renovations of another room of your home unrelated to the home office are generally not deductible.
For both methods, the deduction is limited to the amount of gross income derived from the business use of your home.
Unused amounts can be carried over and used in next year’s return if they relate to the regular method. Unused amounts under the simplified method cannot be carried over to next year.
Whichever method you choose can change from year to year so if you have a fear of tax commitment, no worries, you can choose a new method in 12 months.
Where do I deduct this amount?
So you figured out your deduction and now you want to understand how you claim this benefit.
Well, before you start celebrating and planning a huge home renovation, ask yourself, can you substantiate (1) that the expenses relate to the business, and (2) the amount of the expenses? If not, rethink your calculation and limit it only to amounts you can substantiate.
If you are ready to claim the deduction, the way to actually do that will depend on the type of business you own.
For sole proprietors/ single-member LLCs, the amount will be included on Schedule C of your individual tax returns.
For Partnerships, the deduction will depend on the reimbursement policy set out in the partnership agreement.
For corporations (C corp and S corp), the deduction will need to follow the company’s accountable plan.
An accountable plan is not difficult to set up but it is important to do it correctly in order to make sure your small business can benefit. To get more information on how to claim the home office tax deduction for all types of business entities and how to set up an accountable plan, check out our blog post on Claiming Home Office Tax Deductions – What You Need to Know.
The information provided on this website does not, and is not intended to, constitute legal advice. All information, content, and materials available on this site are for general informational purposes only. Readers are advised to consult with their attorney or accountant with any questions or concerns.
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