Business owners have a goal, and often a fiduciary duty, to pay the minimum amount of tax allowable. Tax planning is the process by which to achieve this goal. One strategy that should be included in any tax planning is the home office deduction.
To take advantage of the home office deduction you must meet the requirements for the deduction, choose your allocation method, calculate your expenses, and ensure proper documentation. Follow these simple steps to verify your eligibility and gain a better understanding of the deduction.
Meet the requirements
The IRS has specific requirements for business owners who want to use the home office deduction. The first is that the space must be exclusively used for business; you can’t deduct your living room as a home office deduction if you also use it to watch TV. The second requirement is that the home office is either the primary place of business or used regularly for meetings.
Once you meet these initial two requirements, you may also have to meet a profitability test if you are self-employed; this means you can’t deduct a home office in a year that your business loses money. These tests can be hard to meet in some situations, like when you have a small apartment, so adjustments to layout or exclusive use might be necessary to qualify.
Choose your allocation method
Choose your allocation method in order to calculate how much of your home expenses you can deduct. Most businesses use the square foot method: calculate the square footage of your home used for business, including square footage used to store inventory or other materials, and divide by the total square footage. If you include an amount in the numerator, also include it in the denominator.
A second widely accepted method is the number of rooms method. You divide one, since most businesses only use one room in the house, by the total number of rooms in your home, excluding hallways and bathrooms. Any method that is reasonable in allocating a percentage of usage between business and personal is allowed, however you must be ready to defend your method if you don’t use the square footage or number of rooms methods.
Calculate your expenses
To determine the actual amount of your deduction, multiply the allocation percentage by your home expenses amount. It’s important to only include home expenses in this calculation. The home office deduction calculation specifically allocates a portion of the dwelling’s costs to the business. Don’t include the cost of an office desk or new computer for the business in this calculation, as these are ordinary business expenses that should be 100% deductible.
The IRS allows a simplified method when you don’t have a lot of expenses or you don’t keep records. However, the simplified method will likely give you a smaller deduction than the actual costs method, as the cost of a dwelling is much higher now than when the IRS set their standard $5 per square foot rate.
Ensure proper documentation
The type of business—sole proprietor, partnership, or corporation—will determine the nuances of what’s deductible and the documents necessary to make the deduction valid. Partnerships must state in the partnership or operating agreement that home office expenses are not reimbursed by the partnerships. Otherwise, the home office expenses incurred by the partner should be reimbursed like any other business expense.
Corporations—both S-corps and C-corps—on the other hand, need to have accountable plans that specifically state that home office expenses are reimbursed. Since owner-employees of a corporation cannot deduct unreimbursed employee expenses under the current tax code (TCJA 2018 to 2025), the only option is to use an accountable plan to reimburse this cost. Some business owners choose to rent their home office to their business, which results in the business having a rent expense. However, this method will cause the owner to claim the rent amount as income and deduct the associated costs.
The home office deduction is a tax-saving strategy that can be used by certain small business owners or sole proprietors to reduce the amount of tax they owe. This deduction is especially beneficial for those who use a large portion of their home for business. This is a popular deduction, so make sure that you qualify, choose the most beneficial allocation method, calculate your expenses correctly, and maintain the required documentation.
This article originally appeared on Forbes