The home office simplified method is an easier way to calculate the expenses you can deduct for the use of your home as a business. Taxable years beginning on or after 2013 are eligible to use this method as an alternative to the standard one.
The standard method to determine home office tax deductions has many calculation and substantiation requirements, so the simplified method is intended to reduce that difficulty.
In this article, we will explain how to use the simplified method, the qualifications you need to meet in order to deduct home office expenses, and how to choose the right method for you.
How to use the simplified method
To determine your home office deduction under the simplified method, you would deduct $5 for every square foot of the space you have designated as a home office. It can only be used for office spaces of up to 300 square feet, meaning your deduction can be a maximum of $1,500 per year.
Using this method you won’t have to keep records of your home office expenses like rent, utilities, mortgage payments, or real estate taxes. And you don’t have to complete an 8829 Form.
The simplified method does not change the criteria for who may apply for home office deductions, it is only a simpler way of calculating and keeping records of the deduction allowed. Read more on the qualifications:
Who can qualify for the home office deduction?
You can qualify for a home office deduction if you are self-employed. This includes freelancers, business owners, and independent contractors who are working for profit. For example, a real estate agent who sends e-mails and makes sales calls from a designated workspace, or an independent web designer who works from home.
If you are an employee who works for a company, you are not eligible even if you have been working remotely and have an office set up in your home. For example, someone working as a customer service representative from home and is on a payroll. Many folks mistakenly believe that if they claim the home office deduction, they will be audited by the IRS. Read our breakdown of the home office deduction audit myth.
What if you are only self-employed for a few months?
You may be able to claim a partial home office deduction if you were self-employed only for a few months. For example, if you did some consulting while you were looking for a full-time job, the home office expenses would be prorated for those few months you worked from home.
But being self-employed (no matter for how long) won’t make you qualify for home office deductions on its own. You will also need to meet other strict qualifications.
How to qualify for home office tax deductions?
To qualify, you must meet any of the following requirements:
Exclusive and Regular Use:
You must be able to prove that you use this space exclusively for business purposes. It does not need to be a separate room, but it has to be in an area where you don’t do anything else. If you use a part of your home such as a room or garage for business purposes but also for some personal purposes you will lose the right to the deduction.
In addition, the home office space should be used regularly, not occasionally, for business purposes. For example, if you have administrative tasks daily but you only do them in your home office once or twice a month you would not meet the requirement.
Principal Place of Business:
Your home office will qualify as a principal place of business if you have no other fixed location where you can conduct administrative or management activities of your business. These include billing, ordering supplies, and bookkeeping.
If administrative and management activities occasionally take place at another business location, or you are outsourcing/delegating some of these activities to others, you will not qualify for the deduction.
You meet with patients or clients:
You can also qualify for home office deductions if you use your home as a place to meet with patients, customers, or clients. The home office doesn’t need to be your principal place of business to qualify if you meet this requirement. However, using your home for this purpose must be essential to run your business.
Daycare Services
If you use your home as a regular space to provide daycare services for children, disabled, or elderly persons, you can claim a deduction for that part of your home. You will be eligible even if that area of your home is used for non-business purposes.
In order to apply, you must have approval under State law to provide such services. If your authorization is rejected or your license is at any point revoked, you will no longer qualify for this deduction.
Limitations of the Simplified Method
There's a home office deduction limitation. Using the simplified method will only allow you to calculate your deductions based on the size of the area used for business. Here is more information on what you will not be able to include in your deductions.
No Other Expenses Can Be Deducted
If you elect to use the simplified method you won’t be able to deduct any actual expenses for the business. Your mortgage interest, real estate taxes, and casualty losses will be considered personal and not business expenses. Track your actual expenses with our home office deduction excel worksheet.
More Than One Home
If you used more than one home for your business during one year, you can only choose the simplified method for one of them. You must use the standard method to calculate deductions for any other home used as a qualified business.
Depreciation Deduction
You cannot deduct any depreciation (including additional first-year depreciation) for the portion of the home that is used for business. The allowable depreciation deductible for that year will be set as zero. This also means you don’t have to recapture any depreciation for the years in which you use the simplified method.
Even though you cannot deduct any depreciation for the portion of your home used for business, the simplified method still allows you to claim depreciation on other assets used in the business like equipment or furniture.
How does the Regular Method work?
When using the regular method, the calculation of your home office deductions is based on the percentage of your house that is being used as an office. The tax-deductible expenses include mortgage interest, utilities, repairs, depreciation, and insurance.
First, you obtain your deductible percentage by dividing your home office square footage by your home’s total square foot. Then, multiply this percentage by the sum of your total allowable expenses and that would be your home office deduction.
Unlike the simplified method, the regular method does not have a limit to how much you can claim.
Example of Calculations:
Let’s say a small business owner has a portion of their house dedicated to selling clothes. The annual gross income from this activity is $10,000. Their entire home is 1,000 square feet, and they are using 400 square feet for their business purposes. This means they are using 40% of their home for business.
Using the regular method this business owner would have to calculate direct expenses (installing a new carpet or painting the wall) as well as indirect expenses (mortgage and utilities). Let’s say they add up to $5,000 annually. The next step would be to take that 40% ratio and multiply it against the expenses (5,000 x 0.4) resulting in an annual deduction of $2,000.
Using the simplified home office deduction they would only have to look at the square footage of the space designated for business. In this case, they would only be able to claim a maximum of $1,500 because the limit is set at 300 square feet.
Choosing the right method:
Once you determine that your home office space meets the requirements you need to choose what method of calculation you want to use. Keep in mind, once you choose your method, it is not possible to change your mind for that year, however, it is possible to select a different method every year.
Many people choose to use the simplified method as a way to avoid the record keeping requirements, but in some situations, you can come up with a lower deduction than you would have if you choose the standard method.
f you have a single-room office and small operations, the simplified method can work well for you. However, if you have many expenses this year that are ONLY related to your home business space, or if your home office space is large, you could get a higher deduction with the standard method.
A piece of general advice to maximize the home office expenses is to calculate the deductions under both methods each year and determine which option comes up with the higher expense. Here's the IRS's comparison of the two methods.
Important points to understand
- Other normal business expenses such as supplies, advertising, and wages are still fully deductible if they are not related to the home business.
- The amount of the deduction cannot exceed the net income of your business, meaning the deduction should not be used to create a business loss.
- If you are using the same home space for more than one business you have to use the simplified method for all of them.
- If you choose to use the simplified method, you will only report your business’ income and expenses on Schedule C (1040 Form) to take the deduction.
As you can see, taking a home office deduction is not easy. Always make sure you understand the general rules and meet the required qualifications. Because of the coronavirus pandemic, employees may receive a home office reimbursement or be fully repaid for any items purchased just for the home office.
Bonsai Has You Covered
Bonsai offers you a business expense tracker and tax software that will make this process easier and faster. It will help you calculate your expense deductions so you can make the right decision and maximize your self-employment tax savings.
