If you have a traditional job, filing your taxes may be simple. You simply have to copy information off your W-2, add up your household deductions, factor in any charitable contributions, and send the information to the IRS.
Individuals who work out of their home face unique tax challenges. As a remote worker or a person running a business from a home office, tax season is much more complicated. A good place to start your tax preparation is by exploring the home office deduction and determining how it applies to your situation.
What is the home office deduction?
The IRS realizes that by dedicating a portion of your home to be used as a home office, you can’t use that space for daily life, which is why they have set up a system that allows you to use the office space as a tax deduction.
There are two ways of going about this: the simplified method and the regular method. There are some things you need to know before including a home office deduction on your tax papers.
The simplified home office deduction
The simplified method of home office deduction is a great option for anyone who has a small home office. To qualify for this type of deduction, your home office can’t exceed 300 square feet. The IRS allows you to deduct $5 per square foot of office space. A 300-square-foot home office entitles you to a $1,500 deduction on your taxes.
The IRS does have two exceptions to the only using the home office as an office rule. The first is if you’re running a home daycare business for either children or seniors, you’re allowed to conduct business besides office work in that part of your home. The second exception is that you can use the space for storage, provided that the storage is business inventory or product samples.
The IRS will not accept your home office deduction if your business failed to generate a gross income that exceeds the amount of the deduction. For example, you aren’t allowed to take the $1,500 deduction if your business only generated a gross income of $1,500 or less.
When you opt to use the simplified method, you’ll use the Schedule A form to itemize your deduction. When you decide to use this particular method, you aren’t allowed to also claim a depreciation deduction for your home. On the other hand, the simplified method means you can earn a profit from the sale of your home and not have to worry about the recapture of depreciation.
The regular home office deduction
The regular method of home office deduction is a great choice if you’re dealing with a larger office space. According to this system, the amount of the deduction is based on how much livable space your home office uses. For example, if your home is 5,000 square feet and your home office is 500 square feet, the office takes up 10 percent of your home. You’ll use that to figure how large a deduction you’re entitled to. The deduction doesn’t stop with your home’s value. You can also include home expenses as well.
If your home office covers 10 percent of your home, you can deduct 10 percent of your annual:
- Utility expenses
- Home insurance premiums
- Mortgage/rent payments
Using the regular method of home office deduction requires that you fill out Schedule A and business Schedule C. The regular method for claiming a home office deduction requires a substantial amount of record keeping.
Which home office deduction method should you use?
As appealing as the idea of getting a deduction on the household expenses may sound, the sheer amount of extra record keeping involved with using the regular method of home office deduction usually means that anyone who has a smaller home office is generally better off sticking to the simplified method of deduction. The good news is that if your business takes off and you find you need more office space, you can enlarge your office and use the regular method for office deduction the next year.
Interesting points some people don’t realize while filing their taxes is that the IRS accepts the deduction even if you rent your home. You’re also allowed to apply the home office deduction if your office isn’t located in the home, but has been set up in a freestanding structure, such as a shed. The freestanding office space must on your home property.