If you have a home-based business, you most likely also have a home office deduction.
But maybe you’ve heard that deducting a home office is a risky tax deduction. Or, maybe you’ve heard that you need to see clients or customers in your office to get the deduction or that you need a separate entrance or that you can’t have any other office to make it work.
None of that is true. Or rather, none of that has been true since the tax law changed in 1997. It’s amazing how much bad and old information still floats around the Internet when it comes to home office deductions.
Here is the truth:
- The home office deduction is legal.
- The home office deduction is safe.
- There are only two tests you must pass: The space used must be (1) regularly and (2) exclusively used for the business.
The space must be used just for the business. It can’t be a corner of the dining room table. It can’t be in the family room, surrounded by computer games and a pool table. That’s the exclusive use part. And you have to regularly use it for business. You may check your emails there, keep confidential material stored there or work off-business hours in your home office. It doesn’t need to be the only business office you have.
Once you have determined that you have a real deduction, now you have to figure out how you’re going to deduct it.
The way you calculate the deduction will depend on the type of business structure you have.
If you have a Sole Proprietorship (Schedule C), you have to report the office on Form 8829 and your home office expense is limited to the amount of income you have from the Schedule C. In other words, you can’t let the home office expense take your taxable income into a loss. But it can reduce your taxable income. Any extra home office expense is carried forward to the next year. So you don’t lose the deduction, just delay taking it.
If you have a partnership, you can either report the home office expense on Schedule E along with the K-1, or you can report the expense through the partnership return as part of a rental expense.
If you have an S Corporation, have the S Corporation report the expense as part of its rental expense.
In both the case of the partnership and S Corporation, you don’t need to report on the extra Form 8829 and your loss won’t be limited.
To calculate the amount to deduct:
- Calculate the business square footage for the space.
- Calculate the total square footage of your home.
- Determine the business use percentage. (business square footage divided by total square footage)
- Apply the business use percentage to total home costs such as rent or mortgage interest, property tax, homeowner’s due, maintenance, utilities and the like.
- Don’t forget to include ‘direct’ expenses for your home office that are related only to the home office space. This may include converting a closet to a work or storage space, new floor covering, installed blinds or drapes, new paint, lighting, even new art work on the walls!
If you have a C Corporation, the calculation is a little different. In this case, the C Corp pays you a fair market rent. The rent is income to you, offset by some of the costs of the house. The challenge, however, is that the IRS specifically disallows home office expenses if you rent any part of your home to your employer (your corporation) and the rented part is used to perform tasks you do as an employee.
The bottomline: Get good guidance on the home office deduction. Don’t believe what you might read on the Internet if it has been written by someone who is not a CPA or attorney.