According to the Small Business Administration, about 50% of all businesses are home-based. If you are one of the many owners of a home-based business, you should consider whether your home office meets the IRS requirements for the home office deduction, which is sometimes overlooked as a way to reduce taxes.
What are the Requirements?
Although the home office deduction was eliminated for employees as part of the 2017 tax reform, owners of home-based businesses may still take advantage of this deduction as long as they meet the following requirements set out by the IRS.
1. Exclusive Use
You must use your home office exclusively for the operation of your business. To qualify as exclusive use, your office must be located in a separate room or rooms, or even a section of a room if you have a clear division, such as a partition, to exclude personal activities from that part of your home. If you use the office during the week, but your children use it as a playroom on the weekend, your office will not qualify for the home office deduction. If you occasionally engage in very limited personal activities, e.g., if you make an occasional personal phone call from your office, just as you might if you worked at another location, this is not likely to disqualify you from meeting the exclusive use test. Note, there are 2 exceptions to the exclusivity rule.
Exception #1. You do not have to comply with the exclusive use test if you use your home as a daycare facility for children, elderly people, or people who are physically or mentally disabled, as long as you have obtained a license or certification required by state law.
Exception #2. If you store product samples or inventory in your home, you can still qualify for the home office deduction even if you use the same space to store personal items, as long as your home is the only location of your business.
2. Regular Use
You must use the space in your home regularly for your trade or business. Although the IRS does not provide a clear definition of what constitutes regular use of a home office, it seems clear that if you use the office several hours a day for activities related to your business, you will likely qualify for the deduction. If the office space is only used incidentally and occasionally, it is unlikely that this use would meet the regular use test.
3. Principal Place for Business Activities
You must use the home office space either as the principal place of business for your trade or business or as a place where you meet and deal with your patients, clients, or customers in the normal course of your trade or business. You will meet this requirement if you use your home office space for your most important business activities and if it is where you spend most of the time you are engaged in business activities.
The IRS has made it clear that your home office is likely to qualify if you use it for the administrative or management activities of your business and do not have another fixed location where you engage in those activities. Thus, even if you do most of your work elsewhere, if your business has just one office, which is located in your home, you probably will pass the test if you use it for business-related administrative or management tasks. For example, if you have a business that installs home security systems, and spend much of your time installing security systems at your customers' property, if you conduct all of your administrative and management activities in your home office, it will likely qualify as your principal place of business. There is however one exception to this rule.
If your home office is located in a separate structure that is not attached to your residence, you can qualify for the home office deduction if you use the space exclusively and regularly for your trade or business, even if it is not your principal place of business or a place where you meet with customers or clients.
If you have a home office that qualifies for the deduction, you can deduct expenses such as the business portion of real estate taxes, mortgage interest, rent, casualty losses, utilities, insurance, depreciation, maintenance, and repairs.
What to Do Next
If you are unsure whether your home-based small business is eligible for the home office deduction or have other tax-related questions, we'll be happy to provide guidance about how to maximize your tax savings and meet your legal obligations. Please contact our office today to set up a meeting.