If you own your own business and you work from home, that can score you a very big tax break…as long as you can stand a little math and some extra paperwork.
First, to be clear, you have to file a Schedule C as part of your tax return to take advantage of the home office deduction. That means you need to earn some work-related income that didn’t come from a regular W2 employer. So if you freelance, have a side gig, or work as a 1099 contractor, you count as a small business. You need to file Schedule C. And if you work from home, you’re eligible for this lucrative deduction.
The home office deduction comes with an easy way and a hard way. If you rent or are using a tiny space for your office, you’re probably better off with the easy way. But the hard way can get you a bigger deduction in most other cases, so it’s worth looking into.
The Easy Way and The Hard Way
There’s a very easy way to take the home office deduction – multiplying the square footage of your space by $5 – but it’s limited to $1,500. That’s it. A little math and you’re done. But you’re also limited to that $5 per square foot, and your home office may be worth more.
In fact, a lot of us with home offices can get a much bigger deduction than that. Especially if your workspace is bigger than 300 sq. ft.
To reap the benefits of the biggest possible deduction, you have to use the original recipe to calculate your tax break. It’s more complex, and you have to calculate and allocate several numbers, and hold on to a lot of paperwork to support your claim. You have to fill out an extra tax form, Form 8829. But it’s absolutely worth the extra work to get the maximum deduction.
Home Office Deduction Requirements
Before we get into the how, let’s make sure your home office meets the conditions for the tax deduction. In order to qualify, you have to meet a couple of important IRS tests:
- Regular and Exclusive Use: You have to use your home office regularly for work, and you cannot use that space for anything else. For example, if you create website content while watching TV in the family room, that wouldn’t pass the exclusive test. But you use half of your dining room as office space, that area could pass the test.
- Main Place of Business: Your home office has to be the home base of your business, your primary spot for getting work done. So if, for example, you travel to meet with clients on-site, but do all of your booking, billing, paperwork, bookkeeping in your home office, that counts as the spot you substantially and regularly conduct business. If you do meet customers (or clients or patients) in your home office, or if you store inventory there, it automatically qualifies.
With that out of the way, now we can move on to exactly what expenses you can deduct, and how to figure out the deductible amount.
What Can You Deduct for Your Home Office?
With a legit home office, you can deduct both direct – meaning things that affect only the office space – and indirect expenses. Indirect expenses cover the whole house, so the office uses a portion of them too.
First, you can fully deduct all direct expenses for your home office. For example, if you had special lighting installed, 100% of that cost goes toward your home office deduction. Other direct expenses include things like a dedicated phone line (a primary home phone line is never deductible here – if you actually have one), a separate Internet connection, and office-specific repairs and maintenance.
Then there are the indirect costs, the ones that cover your whole home. So what indirect expenses can you write off here? For starters…
- Rent
- Mortgage interest
- Property taxes
- Utilities
- Homeowner’s insurance
- Housecleaning
- Pest control
- Home security
For the expenses that you pay for your whole home (like the ones listed above), you have to figure out what percentage actually goes to the home office. The IRS rule says that percentage is based on square feet: Divide the square footage of your office space by the total area of your home. For example, if your home office is 400 sq. ft. and your whole home is 2,000 sq. ft., you could deduct 20% (400/2000 = 20%) of the common expenses for your home office. So if your electric bill was $2,400 for the year, $480 ($2,400 X 20%) would go toward your home office deduction.
You can also take depreciation expense for the business portion of your home. The calculation is a little involved, and you can find the details for that calculation here. It’s almost always worth it to take the depreciation if you can.
Household expenses that have nothing to do with your home office – new kitchen cabinets or lawn maintenance, for example – will not be deductible here.
But the expenses that are deductible can really add up, and put a sizable dent in your tax bill. Don’t be put off by the extra work – tax software can do a lot of the heavy lifting, you just need to have all the expense numbers on hand.
Want More Ways to Save On Your Tax Bill?
Check out my book Taxes 101. I explain our tax system and show you all the deductions and credits available, as well as how to determine whether you qualify for them. That way you can hang on to as much of your hard-earned cash as possible.
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