Self-employed workers, including small business owners and independent contractors, make up about 30 percent of the U.S. workforce.
And with such a large percentage of Americans working for themselves, figuring out self-employed taxes and home office deductions is a major concern.
Yet, the home office deduction is undoubtedly one of the most misunderstood tax deductions.
Many people do not understand the requirements and are afraid it will trigger an audit from the Internal Revenue Service (IRS). Or, they don’t know how to protect themselves if they do claim it on their taxes.
Here’s a breakdown of what the home office deduction actually is, how you can claim it, and how to file for it appropriately.
What is the home office tax deduction?
There are two different ways to file for this deduction. The first is the traditional way, in which the IRS bases your deduction on a percentage of what you pay for your mortgage, taxes, insurance, and utilities.
Then there’s the new, simplified method for calculating your home office deduction. You simply deduct $5.00 per square foot, up to 300 square feet, for a maximum of $1,500. That amount is a valuable deduction that can help reduce your overall tax burden.
What are the home office deduction requirements?
“One of the core requirements for the home office deductions is regular and exclusive use,” says Josh Zimmelman, a tax accountant with Westwood Tax and Consulting LLC. He specializes in helping clients get all of the deductions they deserve.
“You must regularly use your home office exclusively for business,” Zimmelman explains. “For instance, if you use a spare room to run your business, you can deduct that space as a home office.”
“[But] if you just work on a laptop in bed, that doesn’t qualify,” he adds.
One exception to that rule is if you are storing inventory. Then you can deduct the part of your home you use to store product samples or inventory. Even if it’s a closet in a spare bedroom and not exclusively used for business.
And the office must be the primary place of business. If you have another location and only use your home office occasionally after hours, that does not qualify.
To be eligible for a deduction, you must run a small business or freelance. However, some employees do qualify, too.
“If you’re an employee using part of your home for business, you may still qualify for a deduction,” says Zimmelman. “[However] your home office must be for the convenience of your employer, and you must not be renting any part of your home to the employer.”
What else can you deduct?
According to Zimmelman, the home office tax deduction can be particularly useful for homeowners.
“If you own your home, you can claim deductions for depreciations on your home office,” says Zimmelman.
“To calculate this deduction, you need to know the adjusted basis and fair market value of your home at the date you started using it for business,” he explains. “[Then] multiply whichever is smaller by the percentage of your home used for business to determine the depreciable basis of your home.”
When it comes to deducting the depreciating value of your home, the process can be complicated. Consider working with an experienced tax professional who may be able to figure it out for you.
How do you prove your home office’s authenticity?
In the case of an audit, the IRS may call into question your home office’s authenticity.
Many people claim they use their home office exclusively for business. However, in reality, it may also double as a guest bedroom.
Keeping careful records can help protect you if you get audited. Zimmelman recommends maintaining records for at least three years after filing your tax return proving your home office deduction is legitimate.
“Keep evidence that you use part of your home exclusively and regularly for business (and how),” says Zimmelman.
Evidence can also mean taking photos of your home office setup. Make sure to include your desk, computer, and surroundings in the photos. These photos must show that your home office is entirely arranged for work.
Also, keep records of client meetings in your home office, copies of invoices to clients with your home address, and any professional correspondence with your address can also help your case.
And, keep receipts for any home office expenses, like office furniture or business costs. Make sure you have these receipts organized and filed. That way if the IRS does contact you, you will have them readily available.
Get what you’re entitled to
So many people who are self-employed are afraid of filing for a home office tax deduction. Mostly because they fear it will trigger an audit.
However, it’s a very valuable deduction that can help you save a lot of money at tax time. So if you have a legitimate workspace you use for your business, claim the home office deduction and get the savings you’re entitled.
For more information about managing taxes as a small business owner or freelancer, check out this article on why you need a business bank account.