The home office deduction for a side business
If you run a side business from a spare room, a corner of your bedroom, or the garage, part of your housing costs may be deductible. The rules are stricter than most people assume, and a home office claim that fails the tests can be disallowed. This guide explains who qualifies, the two ways to calculate the deduction, and the mistakes to avoid.
Who can claim it
The deduction is available to self-employed people, which includes sole proprietors and single-member LLC owners who file Schedule C. It is not available to employees for their regular job. If your day job lets you work from home, that does not create a home office deduction for you, even if your employer does not reimburse you. The deduction applies to the home-based business income that you report on Schedule C.
The two tests
To qualify, the part of your home you are claiming must meet both of these tests.
- Regular use. You use the space on a continuing basis for business, not just occasionally.
- Exclusive use. You use that space only for business. A desk in the corner of the living room that your family also uses does not qualify. A spare bedroom that doubles as a guest room does not qualify. The space does not need to be a separate room. A clearly defined area can count if nothing personal happens there.
In addition, the space must be your principal place of business, or a place where you meet clients in the normal course of business, or a separate structure on your property used for the business. A space is generally your principal place of business if you use it for administrative or management activities of the business and have no other fixed location where you do a substantial amount of that administrative work. People who earn money away from home, such as a freelance photographer or a tutor who visits students, can still qualify if the home office is where they do their invoicing, scheduling and bookkeeping.
There are limited exceptions to the exclusive use rule for storing inventory or product samples for a business that sells products at wholesale or retail, and for certain daycare businesses.
Method 1: the simplified method
The simplified method is the easy option. You multiply the square footage of your office by $5, up to a maximum of 300 square feet, for a maximum deduction of $1,500. You do not track utilities, rent or depreciation. A few details:
- You still need to meet the regular and exclusive use tests.
- You cannot deduct more than your business's gross income less other business expenses. The simplified method cannot create or increase a loss.
- You can still deduct real estate taxes and mortgage interest, if you itemize, as ordinary itemized deductions.
- You can switch between the simplified method and the regular method from year to year.
Method 2: the regular method
The regular method calculates your actual costs. First find the percentage of your home that the office takes up, either by square footage or by number of equally sized rooms. A 150-square-foot office in a 1,500-square-foot home is 10%. Then apply that percentage to the costs of keeping up the home, such as rent, mortgage interest, real estate taxes, utilities, homeowners or renters insurance, repairs and maintenance, and depreciation if you own the home. Costs that apply only to the office itself, such as repainting that room, can be deducted in full. The calculation is done on Form 8829 and then carried to Schedule C.
The regular method takes more recordkeeping, but it can produce a larger deduction if your housing costs are high. If the deduction is limited by your business income, the unused amount for certain costs can be carried over to a later year.
Comparing the two: an example
Jordan rents an apartment and runs a bookkeeping side business from a 150-square-foot corner that is used for nothing else. The apartment is 1,500 square feet, so the office is 10% of the home. Jordan's annual costs are $18,000 of rent, $2,400 of utilities and $300 of renters insurance.
| Method | Calculation | Deduction |
|---|---|---|
| Simplified | 150 sq ft × $5 | $750 |
| Regular | 10% × ($18,000 + $2,400 + $300) | $2,070 |
The regular method is worth $1,320 more in deductions here. At a 22% federal rate plus self-employment tax, that is a few hundred dollars of tax. Whether the extra paperwork is worth it is a personal call, and many people choose the simplified method to keep life easy. Compare the numbers each year before you decide.
Homeowners: depreciation and the sale of a home
If you own the home and use the regular method, you can deduct depreciation on the business part of the house. When you sell, the part of your gain that equals the depreciation you took, or could have taken, is generally taxed and is not covered by the exclusion on gain from selling your main home. The simplified method avoids depreciation, which keeps the sale of the house simpler. If you own your home and plan to sell it soon, it is worth asking a tax professional how this would affect you.
Common mistakes
- Claiming a room that is not exclusive. The guest room or the dining table does not qualify.
- Claiming the day job's home office. Employees cannot take the deduction.
- Claiming a deduction larger than the business can support. It is limited by the business's income.
- Using a round number with no calculation. Keep the square footage measurements and the bills.
- Double counting. If you deduct business use of a phone or internet connection separately, do not also include it in your home office costs.
Some people avoid the deduction entirely because they believe it invites an audit. The IRS does not say that. If you truly qualify, you may claim it. What matters is that your facts are real and documented. A floor plan sketch or a dated photo of the space, together with the measurements, is an inexpensive way to support your claim.
Where it fits in your overall tax picture
The home office deduction is one of several items on Schedule C. Read our guide to everything you can deduct on side income to see the rest, and see the mileage guide if your business also involves driving. If your home office puts you in a position to claim travel from home to client sites, the home office can make that mileage deductible as well, since the trip begins at your principal place of business.
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Sources
This guide is general information, not tax advice. Tax rules change and individual circumstances differ. Confirm the details for your situation with the IRS or a licensed tax professional.