Small Business Home Office Deductions: What You Need To Know

Small business owners can often deduct the costs of their home office from their taxes. This is known as the home office deduction. To qualify, the home office must be the primary place of business or a place where the business owner meets clients. The space must be used exclusively and regularly for business purposes. Expenses that can be deducted include mortgage interest, insurance, utilities, repairs, maintenance, depreciation, and rent. There are two methods for calculating the deduction: the simplified method, which multiplies the square footage of the office by a prescribed rate, and the regular method, which is based on the percentage of the home devoted to business use.

Home office deduction requirements

To qualify for the home office tax deduction, you must meet the following requirements:

Exclusive and Regular Use

You must use a portion of your home exclusively and regularly for trade or business purposes. This means that the space must be used solely for business and cannot be combined with personal-use space. It should also be used continuously, and not just occasionally. The space can be a room or another separately identifiable space, and it doesn't need to be marked off by a permanent partition.

Principal Place of Business

Your home office must be either the principal location of your business or a place where you regularly meet with customers or clients. This means that your home office should be where you conduct your administrative or management activities, such as billing customers, setting up appointments, and keeping records.

Exceptions to Exclusive-Use Test

You don't need to meet the exclusive-use test if you use part of your home for the storage of inventory or product samples, or if you use your home as a daycare facility for children, older adults, or individuals who are physically or mentally unable to care for themselves. In these cases, you must still meet other requirements, such as having the appropriate licenses or certifications.

Regular Use

The part of your home used for business must be used on a continuous, ongoing, or recurring basis.

Homeowner or Renter

Both homeowners and renters are eligible for the home office tax deduction.

Calculation Methods

There are two methods for calculating the home office tax deduction: the regular method and the simplified method.

The regular method involves calculating the percentage of your home devoted to business use and deducting a portion of your home-related expenses, such as mortgage interest, insurance, utilities, repairs, and maintenance. Direct expenses that are solely for the business use of your home can be deducted in full.

The simplified method uses a prescribed rate multiplied by the allowable square footage of your office. The rate is currently $5 per square foot, with a maximum of 300 square feet and a maximum deduction of $1,500. This method simplifies the calculation and record-keeping requirements but does not change the criteria for who may claim the deduction.

Exclusive use

To qualify for the home office tax deduction, you must meet the 'exclusive use' test. This means that you must use a specific area of your home only for trade or business purposes. The space used for business can be a room or other separately identifiable space. The space does not need to be marked off by a permanent partition. However, you do not meet the requirements of the exclusive use test if you use the area in question both for business and for personal purposes.

The exclusive-use rule doesn't mean that you're forbidden to make a personal phone call from the office or that you have to rush outside whenever a family member needs a moment of your time. Although individual IRS auditors may be more or less strict on this point, some advisers say you meet the spirit of the exclusive-use test as long as personal activities invade the home office no more than they would be permitted to in an office building. The office can also be a section of a room, and you can show that personal activities are excluded from the business section.

There are two exceptions to the exclusive use rule:

• You don't have to meet the exclusive use test if you use part of your home to store inventory or product samples.
• You use part of your home as a daycare facility for people who are physically or mentally unable to care for themselves, or for people aged 65 or older.

Regular use

To qualify for the home office tax deduction, you must meet the following criteria:

Exclusive and regular use

You must use a portion of your home exclusively and regularly for business purposes. This can include a house, apartment, condominium, mobile home, boat, or similar structure. This also includes unattached structures on your property, such as a studio, barn, or garage.

The space must be used exclusively for conducting business. For example, using a spare bedroom as both your office and a playroom for your children will make you ineligible. However, there are two exceptions to this rule:

• If you provide daycare services for children, older adults, or individuals with disabilities, you can use that part of the house for personal activities the rest of the time and still claim business deductions, as long as you have the appropriate license or certification.
• If you use the office for storing inventory or product samples that you sell in your business, and your home is the principal location of your business.

Principal place of business

Your home office must be either the principal location of your business or a place where you regularly meet with customers or clients. If your home office is in a separate, unattached structure, you don't have to meet the principal place of business requirement, as long as you pass the exclusive and regular use tests.

There is no specific definition of what constitutes regular use. If you use a room only occasionally and its use is incidental to your business, you would fail this test. However, if you work in the home office a few hours each day, you would likely pass.

If you are an employee of another company but also have your own part-time business based in your home, you can pass the home office test even if you spend more time at your other workplace.

Principal place of business

The principal place of business is the primary location where a company conducts most of its business operations. It is typically where the business's books and records are kept and where the leadership team is based.

For a sole proprietor or a one-location company, the principal place of business is usually the home, shop, or office where the business is primarily conducted. However, for larger corporations with multiple locations, the principal place of business is typically the headquarters or "nerve center," where the corporation's activities are directed, controlled, and coordinated.

Determining the principal place of business is important for tax purposes and legal matters. In terms of taxation, certain tax deductions may be available to solo practitioners who use sections of their homes as their principal places of business. These deductions can include portions of rent, mortgage payments, and utility costs that reflect the scope of the area dedicated to business usage. Additionally, the principal place of business can impact the type of business taxes that need to be paid in different locations.

From a legal perspective, the principal place of business can affect legal jurisdiction and determine which court will hear legal matters involving the company. If there is a lawsuit between a plaintiff and a defendant business that reside in different states, the concept of "diversity of citizenship" comes into play, potentially resulting in the case being filed in Federal court instead of state court.

To summarise, the principal place of business is a crucial concept for businesses of all sizes, impacting tax deductions, legal jurisdiction, and overall business operations.

Direct and indirect expenses

Direct expenses are those that are incurred solely for the benefit of the home office, such as painting or repairing the office space. These expenses can be deducted in full.

Indirect expenses are those that benefit the entire home, such as mortgage interest, insurance, utilities, repairs, and maintenance. These expenses can only be deducted in part, based on the percentage of the home that is used for business. For example, if your home office takes up 15% of your home's total square footage, you can deduct 15% of your indirect expenses.

Frequently asked questions