The Home Office Tax Hack: Claim Your Maximum Deduction
Wait, your home office doesn't look like this one?! Yeah, neither does ours.
[The following is a guest post by Derek Davis, founder of Shared Economy CPA, which provides tax preparation and consulting services to on-demand economy and 1099 workers.]
Since 95% of Etsy sellers run their businesses from home, taking a deduction for running a home business can save sellers (and other independent workers) a lot of money. The home office deduction is one of the largest tax deductions, anywhere between a few hundred to a couple thousand dollars per year. Here are some criteria you must meet in order to qualify for a home office deduction.
Must Be An “Area Used Solely for Business”
Your home office must be used exclusively for business purposes. There are a few exceptions for day care providers and for inventory storage. However, if these exceptions do not apply to you, and you use your home office for even a bit of non-business use, you no longer meet the requirements of the “exclusive-use” test. Sadly, this even includes using your office as the kids’ playroom when you aren’t doing work.
In order to qualify as an “area used solely for business,” the space must be your principal place of business, or must be used on a regular basis for face-to-face meetings with customers or clients. A good rule of thumb: Generally, to pass the exclusive-use test, non-business activities should never occur in your home office more often than it might be permitted in a professional office setting.
If you use multiple rooms of your home for business, measure the square footage that you use for business, rather than the number of rooms your office occupies. This will allow you to claim a deduction for more than one room of your home, for example, if you have an office for admin tasks, while using a second room as a shipping center for your business.
Taking the Deduction
You should report your expenses on Form 8829, Expenses for Business Use of Your Home, which is required if you are self-employed and claiming this deduction using the regular method.
Hack: If you are worried about the record-keeping that is required with the regular method, you can use the simplified method instead, but only if your home office doesn’t exceed 300 square feet. This 6-line calculation, described in the Schedule C instructions, allows you to deduct $5 per square foot of your office, up to a maximum of $1,500.
Important note: you may leave a lot of money on the table by using the simplified method. An example: You live in a 1,200 sq. ft rental, of which 300 sq. ft is used for your home office, and your rent is $1200/month. Under the simplified method you can deduct $1,500 (300 sq. feet x $5). Using the actual method – with appropriate records – you can deduct $3,600 [percentage of rental used as business is 25% (300/1200), multiplied by annual rent of $14,400 ($1,200 x 12), equals a deduction of $3,600]
Renters vs Homeowners
Renters do not receive any type of tax deduction for rent paid, so the home office deduction – the percentage of rent that can be attributed to the business use of the home – offers the greatest value to renters. Homeowners have the ability to depreciate their property in addition to the home office deduction.
For Homeowners: To claim the home office deduction, you must keep track of interest and real estate taxes, allowable depreciation, and expenses that benefited both the business and your personal circumstances – such as insurance, repairs, maintenance, and utilities for the portion of the home that was used exclusively for business.
Common Mistakes in Taking the Deduction
Many people erroneously claim a home office deduction by misunderstanding what actually constitutes a business.
You’re investment activities may not be a business. While you need to earn money from your efforts, profits aren’t necessarily enough. For example, if you are using your home office to handle personal investment activities, you may not claim this deduction, because your actions as an investor do not qualify as a business. However, you may claim a deduction if your investment activities include the sale of undeveloped land or investment property, or any activities in which the taxpayer works on a regular, continuous, and substantial basis
Use square footage, not number of rooms. Many claim this deduction by using the number of rooms in your home, rather than the actual square footage. Use actual measurements to ensure that you deduct your expenses accurately.
The home office deduction could be worth thousands of dollars to you. Make sure to get it right this year. If you have any questions about this or other 1099 tax issues, feel free to contact us.
[The information above is meant only for guidance purposes and not as professional legal or tax advice. Further, it does not give personalized legal, tax, investment, or any business advice in general.]