Generally, the only expenses you can deduct for your home are interest and real estate taxes. However, if you use part of your home for business, you can deduct part of your utilities, insurance, and repair costs. You can also deduct depreciation on the portion of your home you use for business. Depreciation is an expense you can deduct for the wear and tear on your home when you use your home to produce income.
You do not have to own your home to benefit from deductions for the business use of your home. If you rent a home, condo, or apartment, you can deduct the portion of your rent, utilities, and insurance that relates to the business use of your home. However, you cannot take a deduction for depreciation.
Six situations when you can deduct business expenses for using your primary home.
1. As your main place of business for any business you run. If you use a room, usually an office, in your home only for business on a regular basis, you can deduct the expenses related to the room. Thus, if you are a writer or an artist and you use your home office as your place of work, you probably can take a home office deduction. You also can use your home office as an administrative office and do your work someplace else, as long as you have no other fixed location to do administrative work. Thus, doctors (who perform their primary duties in hospitals), salespeople (who spend time in customers’ offices), and painters and other tradespeople (who spend most of their time at job sites) can probably take a home office deduction.
2. As a place to meet or deal with patients, clients, or customers in the normal course of your business. You must physically meet with people in your home office and not use the room for personal purposes. Making business phone calls from your home is not enough.
3. As a place to store inventory you use in your business. If you regularly use an area of your home to store inventory that you sell from your home by mail or delivery, you can deduct expenses for the portion of your home you use to store the inventory. Storing old records from a business you conduct elsewhere does not qualify.
4. As a place to store product samples for your trade or business.
5. As a day care facility. You must use your home regularly to provide day-care services for children, persons 65 or older, or persons who are physically or mentally incapable of caring for themselves. Your day care facility must be certified or exempt from certification. Generally, if you use your home to provide day care, your deduction is based on the portion of your home that is used, as well as the amount of time in a day the home is used.
6. Use of an unattached , separate building you use only for business. Garages and barns are examples of separate structures that frequently qualify for deduction of expenses. To calculate your deduction, you first gather your home expenses.
You can deduct all the expenses that relate directly to the business area of your home. Examples include the cost of repairs to the room and the cost of painting the room. You can also deduct the portion of your indirect expenses that relate to the business-use portion of your home. Indirect expenses include mortgage interest, real estate taxes, insurance, security, utilities, and repairs and maintenance.
Many people calculate the business use portion by dividing the square footage of the business area by the total square footage of the home. It is also acceptable to base your business percentage on the number of rooms used for business compared to the total number of rooms in your home. Use the method that gives you the higher business-use percentage.
You use a room in your home as an office. The room measures 14 x 16
(224 square feet). The room is one of eight rooms in your home. The total square footage of your home is 2,240 square feet. Using the square footage method, you can deduct 10% (224/2,240) of your indirect expenses. Using the number of rooms method, you can deduct 12.5% (1/8) of your indirect expenses. You can deduct more expenses using the number of rooms method.
If you own your home, you can also depreciate the portion of your home you use for business based on the business-use percentage. Multiply the cost of your home, not including land, by your business-use percentage.
This is the business-use portion of your home. You can depreciate the business-use portion of your home over 39 years (31.5 years if you started to use your home for business before May 13, 1993).
Your deductions for the business use of your home cannot be more than the income from your business. If your deductible home expenses are greater than your business income, then two things happen.
First, you must prioritize the home expenses you can deduct. The ones deductible first are itemized deductions that you can deduct anyway, such as mortgage interest and real estate taxes. Next are home expenses that usually are not deductible and do not affect the basis of your home, such as repairs and utilities. The last expense you deduct is depreciation.
Second, you carry forward the expenses you cannot deduct this year because you do not have enough income. You can use this carry forward against future income from your home business.
You are employed full-time and also operate a second business from your home. You use a room in your basement, which is 15% of the home’s square footage, on a regular basis exclusively for your second business.
Your income from the second business is $10,000. Your business expenses, other than home office expenses, total $7,000. For the year, you pay the following home-related expenses:
- Real property taxes of $2,000
- Mortgage interest of $8,000
- Utilities and other operating expenses of $1,500
- Repair of the wall in your home office of $1,000.
You purchased your home for $120,000, of which $20,000 is allocated to land. Your business income and home office deductions are determined as follows:
Business income $10,000
Less: Other business expenses (7,000)
Subtotal 3,000
Less:
Taxes (2,000 x 15%) (300)
Interest (8,000 x 15%) (1,200)
Subtotal 1,500
Wall repair (1,000)
Utilities and other expenses (225)
(1,500 x 15%)
Subtotal 275
Depreciation (275)
(($100,000 x 15%)/
39 years = $385) limited
to remaining income
Net business income $00,000
Depreciation expenses of $110 ($385 - 275) are not allowed in the current year. You can use the $110 of deductions to reduce your income from the second business in the following year if your income is greater than your deductions.
You calculate your home deductions using Form 8829. The deduction transfers to Schedule C of your Form 1040. The deductible home expenses reduce your self-employment tax and your adjusted gross income.
NOTE: If you take depreciation on your home office and you later sell your home at a gain, you will have to pay tax on your gain up to the amount of any depreciation you deducted after May 6, 1997. Any remaining gain is eligible for the $250,000 ($500,000 if you are married filing a joint return) exclusion when you sell your home. Any gain up to the amount of depreciation you take on your home office is taxed at a maximum rate of 25%, whether or not the $250,000 ($500,000 if you are married filing a joint return) exclusion applies. On the other hand, if you sell your home for a loss, you should use part of the home for business, because you can deduct losses on business property but not personal-use property.
Julie Welch (Runtz), CPA, CFP, and Randy Gardner, LLM, CPA, CFP, are the authors of 101 Tax-Saving Ideas, 9th Edition, published by Wealth Builders Press. To order ($27.95) call 816-561-1400.
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