Many individuals have chosen to run their small businesses from their homes. This is especially true since the pandemic hit in 2020. There are advantages and disadvantages to using your home as your workplace. Among the advantages is the ability to deduct some of the expenses of a home office on your business taxes.
Exclusive Use for Your Business
Before we go into the possible tax deductions allowed, you need to know what qualifies you to claim your home as your business location. This is defined by the IRS as the exclusive use test.
To legally deduct expenses for the use of your home, you must regularly use a portion of your residential property as:
- Your principal place of business
- The location where you do business with clients
- Business inventory storage
- Rental use
- A daycare facility
One caveat is that the portion of your home used for your business must ONLY be used for business purposes. If you use that area for personal activities as well, it does not qualify for applicable tax deductions.
For example, if you have a designated spare bedroom that is specifically used for business, it can be claimed as the home office deductions. But if you also regularly sleep in that bedroom, it does not qualify as an exclusive area for business use.
Another stipulation is that you must be a registered business owner or independent contractor to take the home office deduction. If you are simply an employee of a company who is working from home, you cannot take the deduction.
So What Tax Deductions Are Allowed?
Once you pass the exclusive use test, you are allowed to claim deductions for several expenses of running your home-based business. These deductions are valid whether you own or rent your home. NOTE: It’s important to consult with a certified accountant or tax professional to ensure your tax return is accurate and correct and that you are authorized to claim these deductions.
1. Home Expenses
If you satisfy the IRS requirements for home-based business-related deductions, you can claim a portion of home expenses. You’ll need to determine the percentage of your home that is used for business purposes.
To calculate this figure, divide the square footage of the space(s) you use for business purposes by the total square footage of the home. So, if your home is 3,000 square feet total, and your business office is 300 square feet, you can deduct 10% of your home’s expenses. These expenses include:
- Homeowner's insurance
- Homeowners association fees
- Cleaning services or cleaning supplies used in your business space
- Mortgage insurance and interest
- Utilities, including electricity, internet, heat, and phone
2. Home Repairs and Maintenance
Any repairs or upkeep to your home that are directly related to the space used for your business can be deductible. The deduction amount depends on whether the expense is direct or indirect.
Direct expenses are those that only benefit the space used for your business. These can be claimed at 100% of the expense.
Indirect expenses benefit the entire house, so the square footage formula used in calculating home expenses deductions would apply.
Long-term home improvements, like roof replacements, new siding or windows, etc., can be claimed as an indirect expense but must be depreciated over time.
3. Other Business Expenses
There are other expenses that can be claimed as deductions if they are “ordinary and necessary.” That means that the expense must be typical of and benefit your industry. The following expenses may be claimed for any home-based business, regardless of whether you qualify for the home office deduction.
- Cost of Goods Sold. This pertains to the amount you spend to buy materials and products to manufacture your products. It also applies to items purchased for resale. Related expenses include storage, factory overhead, direct labor costs, and the costs of products or raw materials, including freight.
- Capital Expenses. These costs relate to those items purchased for the purpose of starting, running, and improving your business.
- Vehicle Use. You can deduct certain expenses related to vehicles directly used for your business. Again, a percentage of expenses must be calculated, based on the vehicle’s use for business versus personal use.
- Employees. If you pay other individuals to conduct business for you, these payments typically qualify as legitimate business deductions.
- Retirement Plans. If you and your employees contribute toward a retirement savings plan, there are tax advantages.
- Loan Interest. If you borrow money to benefit your business, the interest charged is deductible.
- Taxes. Certain federal, state, and local taxes levied against your business transactions are deductible.
- Insurance. Costs for business insurance are tax-deductible if it is necessary for your particular business.
- Meals and Entertainment. The normal deduction for business-related meals and entertainment expenses is 50% of the total cost.
- Travel. Business-related travel expenses are typically deductible.
- Supplies. Materials and supplies purchased for the business can be deducted.
- Professional Services. Fees paid to professional service providers, such as accountants, attorneys, contractors, and consultants can be deductible as a business expense.
- Marketing. Expenses related to advertising, marketing your business products and services, getting new customers and keeping current ones, and any business development costs can be deducted.
Ask a Tax Professional
The tax laws are very complex and knowing what you can claim as business expenses on your tax return can be very confusing. Added to that complexity is the fact that these deductions can be claimed using either actual expenses or the simplified method. To avoid audits and steep penalties, it’s always best to consult with a tax professional before making any assumptions.
Nolan Accounting Center helps small businesses with all their accounting needs. We understand small businesses because we are a small business ourselves. Let us assist you and ensure you get all the deductions to which you are entitled.
Contact us today to learn more about how we can help your business succeed.