Home Office: Business Expense?

Whether building a home office is a business expense depends on several factors. If you're a homeowner, you may be able to deduct expenses for the business use of your home, including the business portion of real estate taxes, mortgage interest, rent, casualty losses, utilities, insurance, depreciation, maintenance, and repairs. However, it's important to note that there are specific requirements that need to be met to qualify for these deductions. For example, the space used for business must be used exclusively and regularly for business purposes, and it should be either the principal location of your business or a place where you regularly meet with clients. Additionally, the deductions may vary depending on whether you use the simplified method or the actual expenses method for calculation. It's always recommended to consult with a tax professional or refer to the official guidelines provided by your local tax authorities to ensure you're complying with the applicable rules and regulations.

Home office expenses: what can be deducted?

If you work from home, you may be able to claim tax deductions on certain expenses. The specific rules vary depending on your country and tax jurisdiction, but here is a general overview of the types of expenses you may be able to deduct:

Home-related expenses

Home office-related deductions are typically based on the percentage of your home that you use for business. This can be calculated by dividing the square footage of your office space by the total square footage of your home. It is important to accurately calculate this percentage and only deduct the corresponding portion of each expense.

If you meet the relevant guidelines, you may be able to deduct the following home-related expenses:

• Homeowner's insurance
• Homeowners association fees
• Cleaning services or cleaning supplies used in your business space
• Mortgage insurance and interest
• Utilities, including electricity, internet, heating, and phone
• Repairs and maintenance directly related to your business space

Other business expenses

In addition to home-related expenses, there are also various other business expenses that may be deductible. These expenses must generally be considered ordinary and necessary for your trade or industry. Examples include:

• Cost of goods sold, including storage, factory overhead, direct labour costs, and the cost of products or raw materials
• Capital expenses, such as business startup costs, business assets, and improvements
• Business use of your car
• Employee payments
• Retirement plans
• Rent expenses
• Interest on money borrowed for business activities
• Business taxes
• Business insurance
• Travel expenses
• Supplies and materials
• Professional services, such as accounting, consulting, legal, or contract labour fees
• Marketing and business development expenses

Simplified vs. regular method

When calculating your home office deductions, you may be able to choose between a simplified method and a regular method. The simplified method typically involves multiplying a prescribed rate by the square footage of your home office, up to a certain maximum. This method is generally easier to calculate but may not result in as large of a deduction.

The regular method involves calculating the percentage of your home used for business and applying that percentage to your eligible expenses. This method may be more complex but can result in larger deductions, especially if your business makes up a significant portion of your home.

Important considerations

It is important to carefully review the specific rules and regulations in your tax jurisdiction to determine your eligibility for various deductions. Additionally, if you are an employee working from home, you may not be eligible for the same deductions as a business owner or self-employed individual. Be sure to consult with a tax professional or accountant to ensure you are claiming deductions correctly and in compliance with the applicable laws.

How to calculate the home office deduction

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

The Regular Method

The regular method calculates the deduction as a percentage of your home used for business. This is done by measuring the size of your home office as a percentage of the total square footage of your residence. For example, if your office is 75 square feet and your home is 1,000 square feet, the business percentage is 7.5%. Any direct business expenses can be deducted in full, and any indirect expenses can be deducted at the business percentage. For instance, if you spend $100 to fix a window in your home office, you may deduct the full $100 on your taxes. However, if you pay $1,000 to repair a leak in your roof, you may only deduct 7.5% of that expense.

The Simplified Method

The simplified method uses a prescribed rate, which is then multiplied by the amount of square footage used for business within the home. The prescribed rate can change from year to year and, in 2023, is set at $5 per square foot with a 300-square-foot maximum. This means that a 200-square-foot office would yield a deduction of $1,000. With the simplified method, the space must still be dedicated to business activities.

Choosing the Right Method

While the simplified method may be easier to calculate, it might not provide all the deductions you qualify for. In 2023, the simplified method allows for up to $1,500 in deductions. Therefore, it is important to look at your receipts and expenses for the year to determine which method is best for you. If you are just starting out as a freelancer or a small business, the simplified method will likely work best, as you will likely have fewer expenses. However, if your business is more developed and has more expenses, the regular method should be a better fit, with a $10,000 maximum deduction.

Home office deduction rules and considerations

The home office deduction is a tax break for self-employed people who use part of their home for business activities. Here are some rules and considerations to keep in mind:

• Exclusive and regular use: The space you're claiming must be used exclusively and regularly for business. This means that if you use a spare bedroom as both your office and a playroom for your children, you likely don't qualify for the deduction. However, there are exceptions for those who provide daycare services or use the space for storing inventory or product samples.
• 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 this criterion.
• Employee vs. self-employed: W-2 employees who work from home are generally not eligible for the home office deduction. However, if you have a side hustle or are self-employed in addition to your W-2 job, you may be able to claim the deduction, as long as the space used for the side business is separate from your W-2 job workspace.
• Deduction calculation methods: You can calculate the home office deduction using either the simplified method or the actual expenses method. The simplified method multiplies the square footage of your office space by a prescribed rate (currently $5 per square foot, up to a maximum of $1,500). The actual expenses method allows you to deduct a portion of your total home expenses based on the percentage of your home used for business. This includes direct expenses, such as repairs solely in the home office, and indirect expenses like mortgage interest, insurance, and utilities.
• Record-keeping: If you plan to deduct actual expenses, keep detailed records of all business-related expenses, such as equipment purchases, utility bills, and repairs. This will be crucial if you are ever audited by the tax authorities.
• Home sales and capital gains tax: Homeowners who use the actual expenses method for the home office deduction may need to consider the impact on capital gains tax when selling their home. Depreciation claimed on the home office portion may be subject to capital gains tax upon the sale of the home. However, this may not apply if you use the simplified method.

Home office expenses vs. home business expenses

Home office expenses and home business expenses are both deductible, but they differ in what they cover and how they are calculated. Here's a detailed comparison:

Home Office Expenses

Home office expenses refer to the costs incurred from operating a business or performing employment-related activities within a dedicated space in your home. To qualify for home office expense deductions, your home office must meet specific criteria, as outlined by the IRS:

• It should be used exclusively and regularly as your principal place of business.
• It should be used exclusively and regularly as a place to meet or deal with clients, patients, or customers.
• It can be a separate structure not attached to your home but used in connection with your trade or business.
• It should be used regularly for certain storage purposes, such as inventory or product samples.
• It can be used as a rental for your business or as a daycare facility.

The key distinction is the "exclusive and regular" use of the designated space for business purposes. This means that the area must be used solely for business activities and cannot be a multi-purpose space.

When calculating home office expenses, you can use either the regular method or the simplified method. The regular method involves calculating your actual expenses by determining which expenses are direct, indirect, or unrelated to your business, and then allocating them accordingly. Direct expenses refer to costs directly related to the home office, such as painting or repairs, while indirect expenses benefit both the home office and the entire home, such as utilities or insurance. The simplified method, on the other hand, offers a faster way to calculate deductions by multiplying the allowable area of your home office by a prescribed rate, which is currently $5 per square foot.

Home Business Expenses

Home business expenses, on the other hand, refer to the costs associated with running a business from your home, including both home-related and other business expenses. These expenses are deductible if you are a registered business owner or independent contractor, and they must be considered ordinary and necessary for your trade or industry. Here are some common home-related business expenses:

• Homeowner's insurance
• Homeowners association fees
• Cleaning services or supplies used for your business space
• Mortgage interest and insurance
• Utilities, including electricity, internet, heat, and phone
• Repairs and maintenance directly related to your business space

When calculating deductions for home-related business expenses, you can also use either the regular method or the simplified method. The regular method involves determining the percentage of your home used for business and allocating expenses accordingly. The simplified method, as mentioned earlier, uses a prescribed rate per square foot of the home office space.

In addition to home-related expenses, other business expenses that may be deductible include:

• Cost of goods sold
• Capital expenses, such as business startup costs, assets, and improvements
• Business use of your car
• Employee payments
• Retirement plans
• Rent expenses
• Interest on borrowed funds for business activities
• Business taxes
• Business insurance
• Travel expenses
• Supplies and materials
• Professional services, such as accounting or legal fees
• Marketing and business development costs

In summary, home office expenses specifically relate to the dedicated space within your home used for business purposes, while home business expenses encompass a broader range of costs associated with running a business from your home, including both home-related and other business expenses. Both types of expenses offer tax deductions, and you can choose between the regular and simplified methods for calculating these deductions, depending on your specific situation and eligibility.

Home office tax deduction: who qualifies?

If you work from home, you may be eligible for a home office tax deduction. This deduction can be claimed if you use a portion of your home for your business on a regular basis. This includes any structure that you reside in, such as a house, apartment, condominium, mobile home, or boat.

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

Exclusive and Regular Use:

You must use a portion of your home exclusively and regularly for your business. This means that the space must be used solely for business purposes and cannot be used for other personal activities. The space can be a room or a section of a room, but it must be clearly designated for business use only.

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 you use the space exclusively and regularly for administrative or management activities, such as billing customers, setting up appointments, and keeping records.

Exceptions:

There are some exceptions to the exclusive-use requirement. The exclusive-use test does not apply if you use part of your home for:

• Providing 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 licenses and meet state and local licensing requirements.
• Storing product samples or inventory for your business. You can occasionally use that space to store personal items without losing your home office deduction, as long as your home is the principal location of your business.

Additional Considerations:

It's important to note that the home office deduction is only available to self-employed individuals or business owners. Employees who work remotely for another company are not eligible for this deduction.

To calculate the home office deduction, you can use either the simplified method or the actual expenses method. The simplified method multiplies the square footage of your home office by a prescribed rate, while the actual expenses method allows you to deduct a portion of your total home expenses based on the percentage of your home used for business.

The home office deduction can provide significant tax benefits, but it's important to carefully consider the requirements and consult with a tax professional to ensure you qualify and comply with all the necessary guidelines.

Frequently asked questions