When you work from home, whether you are telecommuting and doing work for an employer, or whether you are running a home business, you may have the option to take a tax deduction for the business use of your home. The home office deduction can be useful, but before you take it, you should consider the pros and cons associated with taking this tax deduction.
How to Figure the Home Office Deduction
First, understand the way the home office tax deduction is figured. You can deduct the costs related to the business use of your home after figuring what percentage of your home is used for business purposes. Let’s consider a home office that is 10 x 10, in a home of 2,300 square feet.
As you determine the value of your deduction, you need to determine what percentage of your home is being used for business purposes. In our example, an area of 100 square feet is being used. Divide 100 by 2,300 to find that 4.3% of the home is being used for business purposes.
Now that you know percentages, you can take a percentage of your rent payment, as well as deduct utilities. If your rent payment is $1,500 a month, that amounts to $18,000 a year. 4.3% of $18,000 is $774. Next, figure out your utility deduction. If you pay $250 a month in utilities, your yearly cost is $3,000. Take 4.3% of that number, and you receive a deduction of $129.
If you are a homeowner, you can also deduct a percentage of your homeowner's insurance premiums, property taxes, and HOA fees. As a homeowner, figuring out your home office depreciation deduction is more tedious than for someone who rents. These steps should serve as a guide:
- Find the percentage of your home used for business purposes
- Figure out the value of your home by subtracting the value of the land (could use local property assessor’s numbers)
- Find the depreciation rules for your home based on when you purchased it
- For example, if it is to be depreciated over 39 years for example, then you would take your home’s value (again less than land) and divide it by 39. Then take that value, and multiply it by the business use percentage (which in the case above was 4.3%) to find your depreciation deduction.
Things to Remember about the Home Office Tax Deduction
It’s important to realize, though, that there are some issues associated with the home office tax deduction. First of all, the area that you deduct must be used exclusively for business. If you are using some of the space for storage, that part can’t be considered part of your home office. It is possible, though, to deduct half a room or even the 4 x 6 area that represents the desk where you do your work.
Before you take the tax deduction, it’s also a good idea to run some scenarios. For some itemizers, a home office tax deduction can trigger the dreaded AMT. If that happens, your deduction ends up costing you more in the long run. You also have to consider the rules related to taking a deduction for home depreciation. Some home workers include home depreciation in their calculations for the home office tax deduction. If you do this, you will have to account for it when you sell your home. If your home gains in value, you will pay capital gains taxes on your depreciation deductions totaled over the years. (A loss on your home, though, results in no taxes, since there is no gain.)
Taking a home office tax deduction can help you reduce your tax liability, and many home workers find it helpful. However, carefully consider the implications of taking the deduction, and make a decision based on what is most likely to benefit you in your individual situation.