If you manage a home-based business, you may be eligible to take a federal tax deduction. Such a deduction can reduce your tax burden, saving you money. However, not every home office qualifies for a deduction. Here is what you need to know before claiming a home office tax deduction.
Small business owners must meet a pair of criteria in order to claim the home office deduction. The IRS requires that the office be used both regularly and exclusively to conduct business or manage your trade. Further, your home must operate as your primary or principal place of business. Fail to meet one or both criteria and the home office deduction does not apply to you.
IRS Publication 587 outlines the regular and exclusive use of what constitutes a home office for deduction purposes.
For instance, if you are an accountant and you use the bonus room in your home to prepare your client’s tax returns and your family also uses the room for playing video games, for watching television or for any other personal use, then you cannot take the deduction. The bonus room, den or other area of the home must be used exclusively for business purposes.
The IRS does, however, permit a pair of exceptions to the exclusive use test. The first exception is if you use part of your home to store inventory or house product samples. The second exception is if you use part of your home as daycare facility. We will look at the first exception only shortly.
If you meet the IRS’ criteria and use your office only a few hours per day or a few days per week, you can still take the deduction. For instance, if you work two or three hours per day in your home office and spend the balance of your time on the road visiting your clients, then the home office deduction still applies.
A Large Room
Business owners with limited space can still find a way to claim the small business deduction.
If you have a large room and partition it into separate sections, the area of the room used exclusively to conduct business can be deducted. For instance, a 20×24 room might be subdivided with one portion used as a living area and the remaining space dedicated for your work area. You will need to measure the square footage of the work area to determine the size of your office space.
You cannot claim another area of the home in addition to your dedicated work space if that area is also used for personal reasons. This may include a dining area where you store a file cabinet, hang a bulletin board and collect your mail. If you also use that room for personal reasons, such as eating meals, it cannot be deducted.
For business owners that use their home to store inventory, the business office deduction can apply. The IRS requires that business owners meet five criteria to claim this deduction.
First, you must sell products at wholesale or retail as your business or trade. Second, the inventory kept inside of your home must be used to conduct your business or further your trade. Third, your home must represent the only fixed location for your business. Fourth, the storage space must be used on a regular basis. Fifth, the storage area must be marked as a storage space for your business. For instance, you may have a closet where you store your goods. To meet this requirement, you could hang a sign saying, “business storage” on the door.
Business or Hobby
Be careful if your “business” is nothing more than a hobby. You may make money selling your woodwork or home crafts, even making a small profit from your work, but the IRS will not permit you to take the deduction if it considers your business to be a hobby.
If you are in doubt about taking the business deduction, consult a tax accountant. Claiming a deduction that is not due you can result in an IRS audit, an adjustment to your previous taxes and fees.
How to Claim the Deduction
If you qualify for a home office deduction, the IRS gives you two choices for claiming a deduction. The first choice is based on your actual expenses. The second choice involves a simplified method.
For actual expenses, you would tally the costs of managing that office according to Forbes. This would include heating, lights, water and other utilities. However, unless your office is metered separately, you may find it difficult to take this method.
The simplified method is as easy as it sounds. The IRS allows you to figure your deduction by multiplying the dedicated square footage of your office by $5. For example, that 10×15 room is 150 square feet. Multiply 150 by $5 and your deduction is $750. The maximum area the IRS allows you to deduct is 300 square feet or a $1,500 business office deduction.
Get Tax Help
Not all home-based small business operators can afford professional assistance when figuring out their deductions and their tax return. Fortunately, IRS-certified volunteers through a Volunteer Income Tax Assistance (VITA) program have been tasked with helping low-to-moderate income individuals for no charge. Through VITA you may qualify for free electronic filing for your tax return and also receive advice on what credit and deductions you may be qualified to receive.
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