Home Office Deduction Part 2 - What Qualifies as a Business?

So, now that you've read about the home office deduction and want to take advantage of the tax break, don't get out the measuring tape just yet. Let's first examine what is actually considered a "business" according the the IRS, followed by the ways in which you would go about calculating the deduction amount.

If you recall in my previous post, titled "Schedule H: Home Office Deduction? Do I qualify?", I mentioned the regular use test, which is more of a qualitative, self assessment. Well, much like many rules that are government issued, the defining characteristics if what constitutes a business need to be considered carefully. The first factor to consider is how substantial are the activities, in terms of time spent and money generated.

But just generating income (and profit) alone are not sufficient by themselves. For one, activities as an investor (stock trading, real estate, etc.) alone do not qualify as a business. on the other hand, if you are managing your rental properties from a home office, you may actually qualify as a property manager instead of an investor.

How to calculate the home office deduction

In simplest terms, your home office business deductions are based on a percentage of your home used for the business. This is more commonly referred to as the business use percentage and is the ration of square footage in your office to the rest of the house. If your office measures 200 square feet and the total size of the house is 2000 square feet, than your business use percentage id 1/10, or 10%. Another way to calculate would be if the rooms in your house are all about the same size, than just divide the total number of rooms used for the business by the total number of rooms in the house.

Now that you have your business use percentage, let's talk about deductions. If you have direct expenses for your home office (spent on repair or maintenance for that space ONLY), the entire cost of those expenses can be deducted. Other expense for your home, called indirect expenses, can be deducted as a percentage of the total cost using the earlier calculated business use percentage. Some if the common indirect expenses that qualify include:

• Utilities

• Homeowners Insurance

• HOA fees

• Security

• Repairs and Maintenance

• Mortgage Interest

• Property Taxes

• Rent

• Depreciation (if you own the home)

Careful consideration needs to be considered when including depreciation in your home office deduction, as that has some other tax consequences that you'll have to deal with later on down the road. You'll have to pay capital gains tax on the amount of depreciation deductions taken when you sell the home (assuming you sold and made a profit).

Simplified square footage method

in 2013, the IRS released a more simplified method of calculating your home office deduction that allows you to take a deduction based on a flat rate amount per square foot, which is adjusted each year. In 2019, that rate is $5 per sq ft and the maximum size you can use is 300 square feet. That means if you do a rough calculation using the business use percentage rate, and it falls below $1,500, than you are probably better off just using the simplified square footage method to calculate your home office deduction this year.

As you can see the home office deduction can improve your overall tax liability, and it doesn't always generate red flag that make you a prime candidate to be audited by the IRS. However, it is also not something to be taken lightly, Whether or not your home qualifies, your business qualifies, and actually how much you qualify for, are all factors to be discussed with a seasoned tax professional.

At Neglco Tax Services, we fully understand the rules of taking the home office deduction, and are ready to assist you and make an assessment of your individual situation. There's nothing more satisfying that finding that one area where I saved my clients some tax dollars", says one of Neglco's tax preparers.

Contact us now to schedule a FREE consultation call and learn more about Neglco can help you.