The tax rules allows for deductions for the business use of your home. This is good news for home business owners. But do you really qualify for home business tax deductions?
Knowing whether you are qualified to deduct the business use of your home in your tax returns is a tricky proposition. There are a number of rules that you must meet before you can deduct your business expenses and your home expenses.
First off, you must meet specific requirements in order to deduct expenses related to the business use of part of your home. The IRS defines “home” for tax purposes as any home business space, including a house, apartment, condominium, or boat. The term also includes any separate structures on the property, including garage, studio, barn or greenhouse.
The government requires that you must meet a number of tests in order to claim expenses for the business use of your home. You can deduct expenses for business use if you use part of your home for one of the following:
- Exclusively and regularly as your principal place of business for your trade or business
- Exclusively and regularly as a place where you meet and deal with your patients, clients, or customers in the normal course of your trade or business; or
- A separate structure used exclusively and regularly in connection with your trade or business that is not attached to your home
- On a regular basis for certain storage use
- For rental use
- As a daycare facility
If you meet the above tests, that’s the only time you can qualify for deductions for business use of your home. If you do not meet the tests, you cannot deduct the use of your home but you can still deduct all of your legitimate business expenses.
If you meet the above tests, your next step is to determine how much you can deduct and what you can deduct. Of course, you can expect more limitations along the way. Your deduction is restricted to the following:
1. Percentage of your home used for business
One common method for figuring you percentage is to divide the area used for business by the total area of your home. So if your office is 200 square feet while your home is 1000 square feet, then your home office is 20 percent of your home. Your business percentage is therefore 20 percent.
Another technique for calculating the percent use is to divide the total number of rooms used for business by the total number of rooms in your house. Note however, that you use this technique if all your rooms are of the same size. So if you use one room for your office in a 5-room house, then your business percentage is 20 percent.
2. Deduction limits
Here comes the tricky part. The IRS allows full deduction of your business expenses only if your gross income from your home business equals or exceeds your business expenses (including depreciation). If your business is not earning yet, or you are operating at a loss, then your deduction for certain expenses is limited and part of your home office deductions will not be deducted this year. Any expenses you cannot deduct this year due to this limitation can be carried forward to next year, up to the point where they do not create a loss.
The IRS rules state that:
You may not deduct you business expenses in excess of the gross income limitation (your gross income derived from the business use of your home less the business portion of mortgage interest, real estate taxes, and casualty losses, and business expenses like salaries and supplies). However, you may be able to carry forward some of these business expenses to the next year, subject to the gross income limitation for that year. If you itemize your deductions on Form 1040, Schedule A (PDF), you may still be able to deduct your personal portion of mortgage interest, property taxes, and casualty losses on that schedule.
Filling up those tax returns, with full confidence that IRS will not be behind your back sometimes requires help. Be sure to consult your accountant or tax preparer to help you understand the tax requirements. Read the IRS’ Business Use of Home for tax rules for home businesses.
For more information, read the following on home business tax deductions:
- What Qualifies for a Home Office Tax Deduction?
- Seven Tax Tips for Home Businesses
- Tax Deductions: Commonly Overlooked Business Expenses
- Tax Time: Check What You Can Deduct from Your Home Office
- Home Business Tax Deductions: What to Watch Out For