Many small business owners, consultants, freelancers, and the self-employed wonder what they’re allowed for home business tax deductions to reduce their taxable income. Homeowners want to get the kind of savings legally allowed for these situations without triggering an IRS tax audit.
It’s good to arm yourself with the information you need in your tax return about which qualifying expenses are allowed for business use of your home. After all, we can use all the help we can get during tax season.
In this guide, we’ll go into detail about which items in your home can qualify for tax write-offs so that you can focus on putting any profits you earn back into growing your small business.
The IRS defines deductible expenses as the cost of carrying on a trade or business. Under this broad definition, many businesses are eligible for home business tax deductions.
To be deductible, an expense for business use of your home must be both “ordinary” and “necessary.” According to the IRS, “An ordinary expense is one that is common and accepted in your industry. A necessary expense is one that is helpful and appropriate for your trade or business.”
It’s also important to separate home-based business expenses from other expenses related to your business, specifically:
Cost of goods sold (COGS) refers to the direct costs of producing the goods sold by a company. This amount includes the cost of the materials and labor directly used to create the good. It excludes indirect expenses, such as distribution costs and sales force costs. COGS is an important part of your business tax return if you make products to sell or you buy products and resell them. This calculation captures production costs that wouldn’t be included in any other way, and these costs reduce your business taxable income.
On the other hand, operating expenses refer to expenditures that are not directly tied to the production of goods or services, such as rent, utilities, office supplies, and legal costs. If you include expenses in one category, you can’t also add them to the other category.
Capital expenses are part of the investment you make in your home-based business, and they must be capitalized rather than taken as deductions. These expenses cover three broad categories:
That said, as a homeowner running a small business and looking for tax cuts, you can decide to deduct or amortize certain business startup costs. Amortization is a method of recovering (deducting) certain capital costs over a fixed period of time.
For the most part, while you can’t take a deduction for a capital expense in the same tax year, you may be able to recover the amount you spend through “depreciation, amortization, or depletion.” These recovery methods allow you to deduct part of your cost from taxes every year.
For the most part, when looking for home business tax deductions and tax credits, you can’t deduct personal, living, or family expenses. The exception to this is an expense used for both business and personal reasons.
For example, let’s say you’re self-employed, and you get a personal loan for $50,000. You use $30,000 to market your small business, while $20,000 goes toward family vacations. As a result, 60% of the loan interest could be used as a business expense on your tax return.
A home office, or business space in a home, can also be tax-deductible if it’s in a single-family home, an apartment, condo, or even a houseboat. A hotel or other temporary lodging can’t be claimed as a home office space.
To act as a qualified home business tax deduction, your space must meet the requirements of regular and exclusive use and be the principal place of your business. The former means that you use the room or space to conduct business only. So, if you use your bedroom as an office during the day and sleep in it at night, the room wouldn’t qualify under this definition.
When deciding the amount of your home office tax deduction, you can calculate this by the simplified or regular method:
As far as your home business property being your principal place of business, this doesn’t disqualify it if you also conduct business elsewhere. For example, if you regularly conduct customer meetings in your home office space, it might still qualify for the deduction even though you also conduct business outside your home, perhaps working in a client office occasionally.
You can also deduct expenses for a separate freestanding structure — such as a studio, garage, or barn — if you use it consistently for your business. For the most part, tax deductions for a home office are calculated according to what percentage of the house space it takes up.
Other home business tax deductions can include:
Running a home office can incur many expenses, ranging from setting up an internet connection and paying the percentage of a mortgage or rent devoted to your home office to paying for office supplies and business cards. So, arming yourself with all the possible deductions is the first step in getting a tax break. The biggest mistake you can make in your business income tax is to claim personal expenses for work-related ones — a practice that may come back to haunt you during a tax audit.
When setting up a qualified home business, it’s also a good practice to rely on the services of a partner who can save you time, money, and headaches. The cost-efficient small business services we provide at ZenBusiness can help you register a business like a limited liability company (LLC), corporation, or S corporation, and determine what permits and licenses you need.
The ZenBusiness Money app can help you track, categorize, and manage all of your business expenses, making tax time considerably easier. Contact us today to see how else we can help you start, run, and grow your business.
Disclaimer: The content on this page is for informational purposes only, and does not constitute legal, tax, or accounting advice. If you have specific questions about any of these topics, seek the counsel of a licensed professional.
If you use part of your home business property exclusively and regularly for conducting business, you may qualify to make home office small business tax deductions. You can possibly deduct expenses such as mortgage interest, insurance, utilities, repairs, and depreciation for that space. You’ll have to figure out the percentage of your house devoted to your business activities, so you can claim the right part of your utilities, repairs, depreciation, and more.
To qualify as a small business, you must have $26 million or less in average annual gross receipts (indexed for inflation) for the past three tax years, and your business can’t be a tax shelter (as defined by the IRS).
You can determine your home office deduction by the simplified or regular method outlined by the IRS. With the simplified method, you would multiply the square footage of your qualified home office space by the set rate of $5 per square foot (up to $1,500). With the regular method, you need to determine the actual expenses of the home office space, including mortgage interest, insurance, utilities, repairs, and depreciation. The size of the deduction is usually based on the percentage size of your workspace versus personal space.
Some people believe that they will trigger an IRS audit for just about any home office expense they claim. This is not the case — there are too many home businesses for the IRS to audit like this. The key to avoiding audits is to claim any legal and reasonable expenses you can, be honest, and follow any available IRS guidelines.
Make sure there’s a clear separation between business and personal expenses in your accounting. Also, keep track of all personal assets you use for business purposes — such as smartphones and internet connections — so you can make accurate claims on your taxes. If you claim a home office, ensure that it passes the exclusive use test. And if you are required to pay estimated quarterly tax payments and self-employment taxes, make sure you put the money aside and pay accurate amounts on time.
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