Home Office Deductions
Copyright 2010 by Morris Rosenthal - - contact info
Copyright 2010 by Morris Rosenthal
Tax Deduction For Business Use Of Home With Form 8829
Warning: These pages are not intended as professional advice. They are presented "as is", reader beware!
There are a few exceptions to the IRS rules that prevent you from deducting mortgage interest as a business expense, the biggest exception of which is the legitimate business use of your home. If you're a sole proprietor and you have a home office, storage, or manufacturing space, essentially all of the expenses associated with that space become legitimate Schedule C deductions. That means that any mortgage interest that you are paying on the percentage of your home that you are using for business goes on Form 8829 rather than Schedule A, and saves you self employment tax and state tax, as well as Federal income tax.
For your home office deduction to be legitimate, the business usage of the space must pass a number of tests. First and foremost, it must be regularly and exclusively used for your business. The exclusively part is critical. If you put an office in a spare bedroom without taking out the bed and put up the occasional guest there, it's not legitimate even if you work in the room 12 hours a day, year round. There's an exception to the dual use clause for home daycare businesses, see Publication 587 for details. If you are a professional (doctor, lawyer, etc) and you set aside a room for consulting with patients, clients or colleagues, that could be enough to get you a deduction even if you aren't carrying out other business activities (administration, etc) in the room. Storage space for inventory is also deductible, even if the inventory is packed from wall to wall on a year round basis. If 100% of your home use is for inventory storage, you can skip form 8859 and take the expense in Part III on the back of Schedule C. But for most of us, business use of the home means the office space that we work in on a daily basis. If you basically do all of your work on the road, your home office should easily qualify as your principal place of business, as long as you regularly use it for administrative tasks and don't have another fixed office location.
The size of the deduction is based on the percentage of the livable space in the home that's used for the business. The IRS is pretty flexible about measurement. The simplest way to come up with a percentage, if the rooms in your house are roughly the same size, is to divide the number of rooms you are using for the business by the number of rooms in the house. I've always used the square foot method, actually measuring the space I was using for the business and than dividing by the square footage of the house. For the square footage of the house, I use the local tax accessor's numbers rather than measuring myself. The maximum mortgage deduction for your home office space is limited just as the maximum mortgage deduction for Schedule A is limited, so be careful if you have a mortgage over a million dollars or a home equity loan over a hundred thousand dollars.
If you rent a house, you can take the deductions the same way, with rent in place of mortgage interest, but you can't depreciate the property. Depreciation allowance is not a big deduction for the average sole proprietor, many choose not to take it because it complicates future tax returns when you move. If you sell the house for a profit, the IRS will want you to recapture the depreciation you've taken, and pay capital gains tax on it, though the gain might be excluded depending on the size and the law at that time. But it brings up an interesting point for self employed business people who are shopping for a home. If you want to maximize your tax deductions, you should buy an expensive house in a nice town with low land value, rather than a cheaper house in a town with high land values. The reason is that land cannot be depreciated. So a town that values the lots at $200,000 and the houses (improvements) at $100,000, is a horrible place to move with the idea of depreciating the cost basis of the house for the business percentage.
An advantage of having a legitimate home office even if you have a rented facility somewhere else for storage, manufacturing, studio space, etc, is that the miles you drive to the secondary facility should be deductible, where otherwise they would be considered "commuting" miles and not deductible. I ran into this last year when I didn't declare a home office and had driven over 1500 miles to a facility I was renting for studio work over the course of three months. That would have been a deduction of around $800 on my schedule C and nearly $400 extra in my pocket if I declared a home office, but the miles were considered commuting instead. The reason I didn't declare a home office was because my home business activity last year was limited to writing in a shared living/working space.
In addition to the deductions for mortgage interest and depreciation or rent, you can also deduct the proportion of any insurance and real estate taxes that cover the area used for business, and, of course, your office expenses. There are some things you have to be careful about, such as deducting the cost of your phone if you only have one phone line in the house. The basic expense for the first phone line is always non-deductible, though given the proliferation of cellphones, the IRS may change that ruling at some point. You can itemize and deduct long distance calls or other business services you add to the line, or a second line. All of the house utilities can be apportioned to the space and deducted, but you also have to remember that deductions, such as mortgage interest and real estate taxes, which you can also take on Schedule A, can't be deducted twice. You have to back out the amount you are taking on Form 8829 before taking the lion's share on Schedule A. There appears to be a bit of a loophole with taking proportional expenses on Schedule C and then using the standard deduction instead of filing Schedule A, but I've never fallen into the circumstance where it would pay so I haven't investigated fully.
Some expenses that you would think you could apportion to the business as well as the home, such as lawn care, are not deductible. The theory may be that the lawn care would have to be done regardless of whether or not you were running a business out of the house. In any case, the IRS has you separate all of the expenses into "direct expenses" and "indirect expenses", where direct expenses are those that pertain 100% to the home office (interior re-painting, a second phone line, etc) and indirect expenses are those that affect the whole house and are apportioned by percentage, such as heat, electricity, taxes, mortgage or rent, etc. Just be warned that if you divide sole proprietors into two groups, those making money and those losing money, the businesses losing money take much bigger mortgage deductions, so it's not a good sign if that's the goal of your business.
Planning A New Business | Estimating Business Taxes | Schedule C Deductions | Car Expenses | Freelancer and Contractor Payments | Section 179 Depreciation and Form 4562 | Employee Benefits and Pension Costs | Professional Services, Business Taxes and Fees | Hotel and Travel Expenses | Deducting Food and Entertainment | Inventory and Cost of Goods Sold | Sole Proprietor Statistics | Home Office Deductions | Self Employment Tax | The Self Employed Sole Proprietor