Having a home-based business has its perks. You get to be your own boss. You have more freedom and flexibility over your schedule (and attire). You can spend more quality time with family and friends. You also get to minimize risk and overhead costs. Plus, you can claim your business expenses as home office tax deductions.
When filing your 2017 taxes this April, you must consider the allowed home office deductions.
Below are key points to consider for you to claim tax deductions for home-based business, as detailed in IRS Publication 587 (rules apply to individuals).
Generally, to qualify for tax deductions, you must use part of your home as your principal place of business operation, or as a place where you do business with your clients or customers. “Home” refers to a house, apartment, boat, condo, mobile home, or another type of property which provides basic living accommodations. However, it doesn’t include any part that is used exclusively as a hotel, motel, inn, or similar establishment for temporary lodging. By this categorical definition, the tax deduction is available whether you are the homeowner or a renter.
Trade or Business Use
First, you must use part of your home in connection with an actual trade or business, and not just for any personal profit-seeking activity. So if you use your study area to manage your stock portfolio, but you do not make investments as an actual broker or dealer, then you cannot claim home office tax deductions since the activity is not part of a trade or business.
To qualify as “exclusive,” you must use a specific area (a room or other identifiable space) for your trade or business. This area doesn’t have to be marked off by a permanent partition, but it must not be used for personal purposes. If you are a website designer, for example, and you work in a spare bedroom which also serves as your kid’s playroom, then the said area is not used exclusively in your trade or business, and so you cannot claim a deduction.
However, there are exceptions. You can still claim tax deductions for a home-based business for parts of your home used for non-business purposes if you use the part in question:
- For the storage of inventory or product samples
If your trade is selling products at wholesale or retail, and your home is the only fixed location of the said business, and you regularly use the separately identifiable space suitable for storage in your home for keeping the inventory or product samples for use in your trade or business.
- As a daycare facility
You can claim a deduction if you are using a space of your home for providing care to older people or those with physical or mental problems. This is also applicable for services that allow you to babysit the younger ones. Furthermore, you must have applied for and been granted (or been exempt from having) a license, certification, registration, or approval to operate as such under state law.
The requisite is there should be a regular usage of a specific area of your home for business. Incidental or occasional business use (such as occasional phone calls) is not considered as “regular” and will not be a basis for home office tax deductions.
Principal Place of Business
Your business may take you to several locations. For instance, you meet with clients somewhere, but your home may still be your “principal” place of business considering the relative importance of activities performed and amount of time spent at each place. For your “principal” place of business to qualify for tax deductions, you must use your home office exclusively and regularly for administrative or management activities of your trade or business. As well, you don’t have any other fixed location where you conduct said operations substantially.
The examples of these activities include billing customers, keeping books, ordering supplies, and setting up appointments. If you, being an employee, use part of your home for work, then in addition to above tests, you must prove that such use is for the convenience of your employer (and not just merely appropriate and helpful for you).
In claiming your home office tax deductions, you may use Actual Expenses or the Simplified method, depending on which would be more advantageous for you.
For Actual Expenses, either direct or indirect, you can claim certain expenses such as real estate taxes, qualified mortgage insurance premiums, home mortgage interest, and casualty losses. These are deductible whether or not you use your home for business. So you need to pro-rate to determine the portion related to home office and other related expenses.
If you are filing using Form 1040 Schedule C, you first compute the deduction on Form 8829 (Expenses for Business Use of Your Home).
For Simplified Method, you can generally compute the deduction by multiplying the prescribed rate ($5 for 2017) by the area of your home used for qualified business use, with the maximum area set at 300 square feet. Under this method, depreciation is treated as zero, and you claim the deduction directly on Form 1040 Schedule C instead of using Form 8829.
Regardless of the method, you may not deduct business expenses more than the gross income limitation.
Make sure to keep records to support your eligibility to claim your home office tax deductions. You have to include vital data in your files such as the amount of your actual expenses, invoices, canceled checks, and receipts. The exact measurements of your home used for your business should also be kept as one of the bases for tax computations.
You can save money by enjoying your legal privilege to have a tax deduction when you use a space of your home for your business. If you’re not sure on what to do, you can consult a tax professional who can help and guide you.