Tax deductions tend to be one of the most important considerations for all taxpayers alike. It is important to make sure that taxpayers have complete knowledge regarding the deductions and claims that are allowed to be claimed on the tax files. One of the most important and critical considerations when it comes to taxpayers is that of home-office expenses.
Home office expenses are referred to as expenses that are allowed to be claimed by people who work and manage their offices from their homes. It is important to note the fact that there are certain expenses that can be claimed for purposes of tax deduction. Alternatively, not all expenses can be claimed for tax deduction-related purposes.
It is important to understand the process behind home-office expenses, and which type of home-office expenses are actually qualified for tax deductions.
Qualifications required to claim home office deductions
What is considered as a home office?
In order to be considered as a home office, the area that is designated is supposed to be used regularly and exclusively for self-employed business. The office space is used as a primary place of business or a separate structure that is used differently for other businesses.
However, it must be noted that there is no requirement in place that requires the home office to be partitioned off from other areas with a wall, or any additional barrier that formally segregates both the parts. For instance, if there is a desk in the corner of the living room where the business is conducted, there is still a possibility of that place qualifying as a home office deduction, as long as that area is not used for any personal use.
Qualifications of a home office
In order to qualify for the home office, the following two criteria need to be met:
- Exclusive and regular use: There is a need to ensure that a specific portion of the house (or the property) is used by the business on a regular basis. This also includes structures on the property, including an unattached studio, or a garage. In the same manner, it also does not include any property that is used exclusively as a hotel, or an office in itself.
- Principal place of business: Home office must either include a principal location of the business, or place where customers come over, and are dealt with on a continual basis. However, there are certain exceptions to this also.
Exceptions to the home office deduction
There are certain exceptions that are in place to the home office rules. For example, in-home daycare businesses are not required to have the exclusive use test. However, in case of home office deductions, there are still requirements in place that need to be considered. For example, the daycare must be in place to provide for people that are mentally or physically unable to carry themselves. Similarly, they are also supposed to have a license, certification, or a registration in place.
In the same manner, IRS also has a guideline in place for individuals that utilize their houses to store business and product samples. It is also important to ensure that certain requirements are met, pertaining to the home office uses. For example, it is imperative for them to sell their products at wholesale, or retail related businesses. In the same manner, samples also need to be kept at home for business related uses. The home should also be the sole business location.
Categorization of home office business expenses
Home office business expenses can be categorized into direct and indirect expenses.
Direct expenses are referred to as the costs that can be applied to the home office, like furniture and equipment, supplies, so on and forth. Direct expenses can be claimed under 100% under direct expenses on the tax return.
On the other hand, indirect expenses are referred to as costs that are not specifically applicable on the home office business, including utilities, rents, mortgage insurance, real estate taxes, so on and so forth. These deductions can further be checked using Schedule A, which contains all the relevant information. In order to find the deductible percentage of these costs, the area designated to the home office is divided with the total area of the house.
How is home-office tax deduction calculated?
Home office business deductions can either be based on percentage of the home, or a simplified square footage calculation.
Percentage of Home Method
The most widely used method of calculating is to measure the square footage that is devoted to the home office, as a percentage of total area of the house. In case where the office measures around 100 square feet, whereas the total area of the house is 1000 square feet, the business percentage would be 10%.
Another easier calculation is also possible in the case where all the rooms are of the same size. In that case, the room used as a home office can also be divided across the total number of rooms in the house.
Simplified Square Footage Method
IRS has a further simplified method of calculating home-office expenses in order to ease the calculation associated with simplified square footage models. For example, in 2021, the prescribed rate of tax was $5 per square foot for every square foot used as home office, with a maximum of 300 square feet. For example, if the square foot used for home office purposes is 100 square feet, then the tax deduction would be equivalent to $500 ($100*$5). However, the condition that the space must exclusively be used for business activities still holds.
Examples of expenses that are deductible
It can be seen that utility portions of all business expenses are tax deductible. This implies that there all basic utilities in the household can be deducted based on the square footage. This includes all utility bills, like electricity, internet and gas.
In the same manner, if the property is on lease, then the lease costs, or the rental costs can also be subtracted as deductions from the home office. However, the calculation of these expenses must be accurate to avoid any red flags on the part of the IRS.