What is a Home Office Expense?
A home office expense refers to the costs incurred through the performance of work-related activities that provide an additional source of income within a primary residence. When work performed in the home office produces outside income, the Internal Revenue Service allows employees to make a tax deduction from the annual tax return if they meet certain requirements. Examples of office expenses may include the internet bill, phone lines, utilities, cost of stationeries, taxes, etc.
- A home office expense is a cost incurred by an employee running official business functions at a home office.
- Home office expenses can reduce the tax burden from the annual returns of an employee who works at home.
- Exclusive and regular use of a home for business purposes is the qualifying factor for claiming home office expenses.
Understanding Home Office Expenses
Home office expenses enable self-employed business owners to claim a tax deduction from their annual tax returns for house expenses such as property taxes and mortgage interests. The house expenses can also include additional running costs ranging from an internet subscription to electricity bills. Most often, employees working from home bear zero capital gains tax (CGT) implication for their homes.
Fully deductible utilities are those that are exclusively used to conduct business. For example, computer equipment, phone lines, and office supplies constitute home office expenses. The deductible amounts are determined by several factors – such as homeowner’s earnings and tax remittance. However, home office expense is commonly claimed as an expense as long as they accrue in the course of a business operation.
Ideal Home Space for Business
In order to claim home office expenses, an individual must exclusively and regularly use the space in question for conducting business. Exclusive use means the office space is meant for nothing other than conducting business. In contrast, regular use implies that the room is utilized regularly, rather than on certain occasions. Under such a framework, a home office must meet either of the following criteria:
- It must be a separate structure and disjointed from the main house and only used for business operations.
- It must be regularly used as a storage facility.
- It must be a place where the business owner meets patients, clients, or customers.
- It must be a rented place solely for business or daycare facility.
A home office does not necessarily need to be permanent, and using such space for the dual purpose of business and personal use disqualifies it from being a home office. A home office can be located in the corner of the house, with arrangements only used to transact business. However, conducting business using a laptop while sitting on the sofa among family members does not qualify for a home office.
Method for Calculating Home Office Expenses
According to the IRS, there are two approaches used to calculate the number of deductions and how much space constitutes a home office. One of such methods is the regular method, which involves calculating expenses. The second method is the simplified method, which is relatively ineffective since it may not yield a wide range of deductions.
1. Regular Approach
The regular method requires accurate record-keeping, and the accounting of home expenses starts by finding the following:
- Direct, indirect, or unrelated business expenses
- Percentage of a home used exclusively for business purposes
Direct expenses are utilities such as aesthetics or renovations in the areas only meant for business. On the other hand, indirect expenses are the costs incurred from general repairs, utilities, and insurance premiums. The IRS further provides the following two methods to establish the allowable portion of a home:
- Find the home’s total area and divide it by the area of the space used for business.
- The number of rooms exclusively used for business can be divided by the total number of rooms in the home if the rooms are similar in size.
2. Simplified Approach
The simplified method is appropriate, especially if a home office is on the small side. The following criteria are considered when calculating home office expenses using the simplified approach:
- The same space in a home is used exclusively and regularly for conducting business. An allowable area must be established, especially if space changed or was never used in an entire year.
- The total income that the business conducted at a home office can generate.
- Additional costs incurred that are not related to the use of the home office.
- The percentage of time may also be necessary for home spaces used for services such as daycare.
The forbearing information can be used to calculate home expense deductions by following the procedure below:
- For a home space not used for daycare, find the product of the allowable area and multiply by $5.
- Subtract costs unrelated to business use of the home. Deductions from the business use of a home cannot be claimed if these costs are higher than the home office expenses.
- The smaller amount between (1) and (2) is the home office expense to be deducted.
However, there are limitations to the above method. For example, in the case of a shared space, they both cannot be deducted. The Publication 587 include additional restrictions of the simplified approach.
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