In the US, there are two methods to calculate home office expenses: the Simplified Method and the Regular Method. Each method has its own rules and calculations, and pros and cons depending on your circumstances. Let’s go through them below.
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The Simplified Method is the simpler and easier method of taking a home deduction because you don’t actually have to deduct individual expenses. The Regular Method involves a lot more steps and actually involves deducting individual expenses.
The Simplified Method
With the Simplified Method, you “simply” take the square footage of your home office space and multiply it by $5 per square foot. The $5 is a prescribed rate set by the IRS and the maximum square footage you can claim is 300 square feet. Therefore, with the Simplified Method, you can get a tax deduction of up to $1,500.
Steps to use the Simplified Method
- Measure the square footage of your home office area. This should be a dedicated space used exclusively and regularly for your business activities.
- Make sure that it’s under 300 square feet.
- Multiply the square footage by $5.
- The total is the amount you can deduct as your home office expense. For example, if your home office space is 200 square feet, your deduction would be 200 x $5 = $1,000.
The Regular Method
With the Regular Method, you first need to calculate the percentage of your home that’s used for your home office space. If you use a 500 square foot den to conduct your business in a 5,000 square feet home, that means you use 10% of your home for business.
Direct expenses (like repairs or maintenance specifically done for your office) are fully deductible while indirect expenses (like mortgage or rent, insurance, utilities, and general home repairs) are deductible based on the percentage of your home that’s used for business purposes.
Steps to use the Regular Method
- Measure the square footage of your home office area. This should be a dedicated space used exclusively and regularly for your business activities.
- Next, measure the square footage of your entire home, including the home office space.
- Calculate the business use percentage by dividing the square footage of your home by the square footage of your home office space.
- Keep accurate records of your home expenses such as mortgage, rent, property taxes, utilities, insurance, maintenance, and repairs.
- Determine which expenses are direct expenses and which are indirect expenses. Direct expenses are fully deductible and involve any costs incurred directly for your home office space. Indirect expenses are more general costs for your home including rent and mortgage payments.
- Calculate the deductible amounts on your indirect expenses by multiplying it by the percentage used as an office space. For example, if you use 15% of your home to conduct business, 15% of your rent or mortgage payment would be deductible.
- Total your deductible home office expenses by adding up all the deductible portions of your eligible home expenses. This total will be your home office deduction for the tax year.
Which method should you use?
The Simplified Method is usually best for small businesses that use a small portion of their homes not greater than 300 square feet. The upside is that you’re not required to meticulously keep records of all your expenses. You can simply take your square footage used for business and multiply it by $5. The Regular Method involves deducting individual expenses and requires more documentation, record-keeping, and calculations come tax season.
If you’re trying to choose between the two, here are some things to consider:
The Simplified Method is simpler
The Simplified Method requires less record-keeping and is less complicated. You only need to know the square footage of your home office and apply the prescribed rate ($5 per square foot, up to 300 square feet). This method might be suitable if you prefer a simpler calculation or if you don’t want to keep detailed records of your home expenses.
The Regular Method can result in a higher deduction
The Regular Method may result in a higher deduction if you have significant home expenses that are proportionally higher than the $5 per square foot rate used in the Simplified Method. However, this method requires more record-keeping and calculations. If you believe the Regular Method will yield a substantially larger deduction, it might be worth the extra effort. If you’re already documenting all of your expenses already, you can do some quick calculations to see if it will be worth the effort to file using the Regular Method over the Simplified Method.
You can change methods each year, but not during the same year
Once you choose a method for a particular tax year, you cannot switch to the other method for the same year. However, you can change methods in future tax years. If your home expenses or business use percentage change significantly from year to year, you might prefer to use different methods in different years.
The Regular Method allows you to carry forward losses
The downside of the Simplified Method is that you cannot carry forward losses. If your business has a loss on your schedule C, you don’t get to take this deduction, you just lose it.
Unlike the simplified method, you can carry forward a loss using the Regular Method. If taking a home office deduction creates a loss in your business, you don’t lose that expense. It just carries forward to a future year for you to take.
You need to depreciate the value of your home if you own your home and use the Regular Method
If you own your home and use the Regular Method, you have to take a depreciation expense as well, which involves allocating your building costs, land costs, and depreciating the building cost, and taking a percentage of that as a deduction, too. If you eventually sell the house, you are going to have to recapture those depreciation costs. If you use the Simplified Method, you don’t need to factor in depreciation.
Who is eligible for the home office deduction?
Any small business owner or self-employed individual can claim the home office deduction as long as the area is your principle place of business, and used regularly and exclusively for your business. All business entities are eligible, even if you’re not incorporated, and you qualify whether you rent or own your home.
In addition, it’s not just a home that qualifies for the home office deduction. Any freestanding structure, like a studio, garage, barn, or tiny home, could be eligible for the tax deduction as long as it meets the two rules below.
Principal place of business
Your home office should be your principal place of business or a place where you regularly meet with clients, customers, or patients. The IRS considers your home office as your principal place of business if you perform the majority of your administrative or management tasks there, even if you conduct business at other locations.
Exclusive and regular use
You must use a specific area of your home exclusively and regularly for your trade or business. This means the space should not be used for personal activities, and you should consistently use it for your business. It doesn’t necessarily have to be a separate room, but it should be a clearly defined area.
Also read: Biggest Tax Deductions For Businesses