If you run a business from home, don’t miss out on the home office deduction

Vlad Rusz is a CPA in Centaur Digital Corphelping busy business owners manage their accounting system efficiently.

Business owners have a goal, and often a fiduciary duty, to pay the minimum allowable amount of tax. Tax planning is the process by which this goal is achieved. One strategy that should be included in any tax planning is the home office deduction.

To take advantage of the home office deduction, you must meet the deduction requirements, choose an allocation method, calculate your expenses and provide the appropriate documentation. Follow these simple steps to confirm your eligibility and better understand the deduction.

Familiarize yourself with the requirements

The IRS has special requirements for business owners who want to use the home office deduction. The first is that the space must be used exclusively for business purposes. You can’t take your living room as a home office deduction if you also use it for watching TV. Another requirement is that the home office is either the primary place of business or is regularly used for meetings.

Once you meet these two initial requirements, you may also need to meet a profitability test if you are self-employed. This means that you cannot deduct a home office in a year in which your business loses money. These tests can be difficult to meet in some situations, such as when you have a small apartment, so layout adjustments or exclusive use may be necessary to qualify.

Choose your allocation method

Choose an allocation method to calculate how much of your home expenses you can deduct. Businesses can use the square footage method: Calculate the square footage of your home used for business, including the square footage used to store inventory or other materials, and divide by the total square footage. If you include an amount in the numerator, include it in the denominator as well.

Another accepted method is the number of rooms method. Divide one (since most companies only use one room in the house) by the total number of rooms in your home, excluding hallways and bathrooms. Any method that is reasonable in allocating the percentage of use between business and personal is allowed; however, you must be prepared to defend your method if you do not use the square footage or number of rooms methods.

Calculate your costs

To determine the actual amount of your deduction, multiply the deduction percentage by the amount of household expenses. It is important to include only household expenses in this calculation. The calculation of the home office deduction specifically allocates a portion of the housing expenses to the company. Do not include the cost of an office desk or new computer for the business in this calculation, as these are ordinary business expenses that should be 100% deductible.

The IRS allows a simplified method when you don’t have a lot of expenses or don’t keep records. However, the simplified method will likely give you a smaller deduction than the actual cost method, since the price of the apartment is much higher now than when the IRS set its standard rate of $5 per square foot.

Provide appropriate documentation

The type of business—sole proprietorship, partnership, or corporation—will determine the nuances of what can be deducted and the documents required to make the deduction valid. Partnerships must state in the partnership agreement or operating agreement that partnerships do not reimburse home office expenses. Otherwise, home office expenses incurred by the partner should be reimbursed like all other business expenses.

Corporations—both S-corps and C-corps—on the other hand, must have accountability plans that specifically state that home office expenses are reimbursed. Since owner-employee corporations cannot deduct unreimbursed employee expenses under current tax law (TCJA 2018 through 2025), the only option is to use an accountable plan to offset that expense. Some business owners choose to rent out their home office for their business, which results in rental costs. However, this method will result in the owner claiming the rental amount as income and deducting related expenses.

The home office deduction is a tax-saving strategy that some small business owners or sole proprietors can use to reduce the amount of tax they owe. This deduction is especially useful for those who use a large part of their home for business. This is a popular deduction, so make sure you meet the requirements, choose the most favorable distribution method, correctly calculate your expenses and keep the necessary documentation.

The information provided here is not investment, tax or financial advice. You should consult an authorized professional for advice regarding your specific situation.

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