The idea of working from home is undoubtedly admirable. In addition to not having a commute, the costs that come with using a home office can really help self-employed individuals with their tax bill. These expenses are classified into two categories:
Direct Expenses: relating to costs that are incurred specifically for the space that is considered the "home office." For example, the costs of painting or repairing the home office, depreciating the furniture and fixtures used in the office, etc.
Indirect Expenses: relating to costs that are incurred for the entire house. Such as, utility
costs, depreciation, insurance, mortgage interest, real estate taxes, etc. The allocable share of
these costs will be applied as a home office deduction. For example, if your home’s total footage is 1,000 Sq ft. and your home office is 200 Sq ft., 20% of the total indirect expenses would be deductible.
Of course, there are plenty of rules (discussed below) that one must satisfy in order to utilize such tax deductions. If you meet any of these three tests, you will be able to deduct your home office expenses.
Principal place of business: You're entitled to home office deductions if you use your home
office, exclusively and on a regular basis, as your principal place of business. Your home office is
your principal place of business if it satisfies either a "management or administrative activities" test, or a "relative importance" test. You satisfy the management or administrative activities test if you use your home office for administrative or management activities of your business. You meet the relative importance test if your home office is the most important place where you conduct your business, in comparison with all the other locations where you conduct that business.
Note: With your home office serving as a “principal place of business,” the costs of traveling between your home and other work locations are considered deductible transportation expenses.
Home office used for meeting patients, clients, or customers: You're entitled to home office deductions if you use your home office, exclusively and on a regular basis, to meet or deal with patients, clients, or customers. The patients, clients or customers must be physically present in the home office.
Separate structures: You're entitled to home office deductions for a home office, used
exclusively and on a regular basis for business, that's located in a separate unattached
structure on the same property as your home-for example, an unattached garage, artist's studio,
workshop, or office building.
In last week’s blog post, we discussed the tax effects of selling your home. As a refresher, when selling your primary residence, a capital gains exclusion of $250,000 (single) or $500,000 (married) is applicable – subject to certain rules. When selling a home that contains a home office, that same exclusion will not apply to the portion of your profit equal to the amount of depreciation you claimed on the home office. This can be an important factor when deciding whether or not to establish a home office for tax purposes.
Home office deductions can be tricky, and each person’s situation is different. We understand that self-employed individuals want to run a thriving business, while minimizing their tax bill – reach out to us and make sure you’re taking advantage of ALL of your allowable deductions!