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How to Calculate Home Office Deduction


WHAT is it description: At the most basic level, this deduction lets you reduce the amount of taxes you owe by claiming the space in vour home that's dedicated to working as a business expense. In other words Home office expenses are expenses incurred from the operation of a business or the performance of employment-related activities within a primary residence.


HOW it works explanation: The IRS allows two different methods of calculating your deduction:


Simplified Method: If you have a small space, you may use the simplified method, which allows you to do a simple calculation. Find the square footage of your home office space and multiply that by $5 a square foot. The maximum space is 300 square feet, for a maximum deduction of $1,500. There are some limitations to this method:

  • You can't take a home depreciation deduction or recapture de preciation for years you use this method

  • You can't use the deduction to take a business loss,

  • And you can't carry over any amount to a future year.

Detailed Method: If you have a larger space or you have a complicated situa-tion, you will need to use the more detailed method. To use this method, vou'll first need to calculate the space in vour home used for business (requ-larly and exclusively, of course). You will be doing these calculations on IRS Form 8829 and including this form on your business tax return. The space used for the business is determined by one of two methods:

  • Area Method: Divide the area used for your business by the total area of your home. For example, if your home is 2000 square feet and your home office is 400 square feet, your office space is 20% of the total area of your home.

  • Number of Rooms Method: Divide the number of rooms used for business by the total number of rooms in the home (use this method if the number of rooms is about the same).

In most cases, the area method is the best, since most homes do not have rooms of equal size.

  • Itemize Home Office Expenses. The next step is to determine the kinds of home business expenses you can deduct. In addition to your other business expenses, the IRS allows you to deduct and indirect expenses that are related to the "business use of your home." Be careful to separate business expenses from per-

Direct expenses: are those used only for the business section of your home.

An example would be paint, wallpaper, and carpeting used only in that area.

You can deduct these expenses at 100% because they are only related to vour business.


Indirect expenses: are those paid for running your home which can be deducted based on the percentage of the home used for business (see

"Calculating Your Home Office Space Deduction"). Typical indirect expenses include rent/mortgage interest, utilities, insurance, and general home repairs.

To determine the total indirect expenses, list all of your total home expenses for the year. Here is a partial list:

  • Rent or Rea estate taxes

  • Deductible mortgage interest

  • Homeowner's insurance premiums (unless you have separate insurance for the business part of your home)

  • Some home repairs (if they affect the home business space)

  • Utilities and services, such as electricity, gas, trash, water, and sewer. (Telephone expenses are discussed below)

  • Depreciation. To calculate depreciation on your home, use the lesser of (a) the fair market value of your home on the date you first used it for business, or (b) the purchase price (excluding land) plus maior improvements minus casualtv losses or other changes to your home's basis.

WHY execute the process: Home office expenses allow individuals to deduct some housing expenses such as utilities, interest paid towards the property's mortgage and property taxes on their annual tax return.


BENEFIT/OUTCOME: 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) implications for their homes. The home office deduction allows vou to deduct a portion of the cost to run and maintain your home as a business expense. Done properly, this deduction can reduce vour taxable income substantially, generating a tax savings.

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