Tax Deductions for Home-Based Businesses
The rise of home-based businesses represents a fundamental shift in the way Americans work. Home businesses offer their owners a convenient and flexible way to earn income without commuting to a traditional office. They may also qualify for tax breaks in the form of home office deductions.
Self-employed individuals, who pay their own Social Security and Medicare taxes under the Federal Insurance Contributions Act (FICA), can reduce their tax burden by deducting some costs associated with running their home business. The Internal Revenue Service (IRS) has strict rules about who qualifies for this deduction, so it is important to understand whether you are eligible for it and which expenses are deductible.
Home Office Deductions: Who Qualifies and What You Can Claim
Under the Tax Cuts and Jobs Act of 2017, for tax years 2018 to 2025, W-2 employees cannot deduct unreimbursed employee business expenses, including the home office deduction, even if they work from home. Only business owners, freelancers, and gig workers currently qualify for the home office deduction. However, W-2 workers who have a side-hustle home business that qualifies for the home office deduction may also claim the deduction.
According to IRS rules,[1] you can deduct business-related expenses for the use of your home if you meet the following requirements:
● You use a portion of your home to conduct business exclusively and on a regular basis.
● Your home is your principal place of business or a place where you regularly meet with clients or customers.
Exclusive and Regular Use
The IRS considers an office-in-home to be an area separated from the home’s living area that is used exclusively for business, such as meeting customers, dealing with clients, maintaining books, and performing other activities in the normal course of conducting business.
● A home may be a house, apartment, condominium, mobile home, boat, or similar structure.
● A separate structure on the property not attached to the home, such as an unattached garage, studio, or barn, may also qualify for a home office deduction.
Under the exclusive use requirement, wherever your home office is located, it must be the primary space where you conduct business, and it must be dedicated to work. Avoid using your home office for personal activities to ensure eligibility to claim the deduction. This does not mean you cannot make a personal phone call from your home office, or that you must leave your office if a family member demands your attention. If minimal personal activities do not overlap with home office activities any more than they would at a traditional office, the exclusive use test should be satisfied.
In addition, the exclusive use requirement does not apply to some business activities, such as providing in-home services (such as childcare and elder care services) or storing inventory at home.[2]
The IRS regular use requirement is somewhat less clear and depends on the facts and circumstances of each situation. Working in a dedicated home office space eight hours per day, five days a week, or even working there several hours a day probably constitutes regular use. But if you do not keep regular hours and only work there occasionally, you might fail the test.
Principal Place of Business
To evaluate whether your home-based business satisfies the principal place of business test, you must determine if “your home is the principal place of your trade or business after considering where you perform your most important business activities and where you spend most of your business activity time.”[3] The IRS notes that if you use your home to conduct business but also conduct business outside of your home, you may still qualify for a home office deduction as long as you do not perform administrative or management activities at any other fixed location.[4]
Types of Deductible Expenses
Home office deductions can be made using the simplified method or the regular method. The simplified home office deduction is based on the percentage of your home used for business, at $5 per square foot, up to 300 square feet. For example, if you have a 2,000 square foot home, and 10 percent (200 square feet) is dedicated to your home business, multiply 200 x $5 for a simplified home office deduction of $1,000.
The regular method for calculating the home office deduction also relies on a percentage of the home used for business. Unlike the simplified method, however, there is no limit on the maximum square footage. The regular method also allows you to deduct your actual expenses, including the following:
● depreciation
● mortgage interest
● insurance
● maintenance
● rent
● repairs
● utilities
Taxpayers can elect to use the simplified or the standard method for a given tax year. Once an election is made, they must stick to it for that taxable year—but they can switch to a different method the next year. Use IRS Form 8829 to calculate the amount of the deduction for expenses for the business use of your home.
Call Us Today
You might be unsure about whether you qualify for the home office deduction, how much you can write off, and which method is right for your tax situation. Schedule a meeting to discuss the home office deduction or any legal questions related to your home-based business.
[1] Topic No. 509, Business Use of Home, IRS, https://www.irs.gov/taxtopics/tc509 (Jan. 30, 2024).
[2] Id.
[3] Id.
[4] How Small Business Owners Can Deduct Their Home Office from Their Taxes, IRS, https://www.irs.gov/newsroom/how-small-business-owners-can-deduct-their-home-office-from-their-taxes (Nov. 14, 2023).
