It’s a real bonus as a freelancer to be able to work from home. No commuting, no office politics, and you can often set your own hours of work. Another bonus is being in control of your self employment taxes and able to claim tax deductions for a home office.
There are expenses to setting up and maintaining an office at home, from the initial purchase of computers and office equipment to the ongoing homeowner costs of house insurance, utilities and more.
The good news is that some of your home expenses can be used as tax deductions for a home office, helping to offset how much you pay at tax time, and increase your profits for the year.
Let’s take a look at everything you need to know about tax deductions for a home office.
If you would like an app to help you track your home office tax deductions and other write-offs, try Bonsai Tax. Our app helps save freelancers an average of $5,600 from their tax bill. Our software just works. Try a 7-day free trial today.
1. What constitutes a home office?
In order to claim tax deductions for a home office, the Internal Revenue Service (IRS), the federal taxing authority, does have some requirements.
The first requirement is that your home is your principal place of business. In other words, your office is located in your home and that’s where you do most of your work. If you do conduct business elsewhere, you could still qualify for tax deductions for a home office as long as you use your home “substantially and regularly to conduct business,” in the words of the IRS.
The second requirement is that you regularly use a part of your home exclusively for your business. For example, you have a spare room that has been converted into an office, or a garage that has been converted into a studio, and you use that space for your freelance business. Due to the COVID-19 pandemic, many employees could qualify for a home office reimbursement as well.
2. What are some examples that qualify as a home office?
Even if you conduct some of your work elsewhere, you would still be able to deduct expenses for that part of your home used exclusively and regularly for business. As well, if it’s not the only place you meet clients, or the main place you conduct business, it can be used as long as it is used exclusively and regularly for business.
Here are some other scenarios.
Let’s say you work as an employee and are a part-time freelancer who uses a home office. You can use the tax deductions for a home office even if you’re at your employer’s office most of the time. That’s because the home office is the principal place of your freelance business, not your principal office where you spend all your time.
If you use the home office to do most of your administrative work, but your freelance work is done elsewhere - examples include in-person photography shoots or on the road doing sales - you’re still eligible for home office deductions.
You’re also eligible for tax deductions for a home office whether you own or rent your home, and for any type of home, including a house, apartment, condominium, or even a houseboat.
If it’s simply helpful to have an office in your home that you occasionally use for business, but usually the kids are in there doing homework, then you can’t claim tax deductions for a home office. It might be best to seek advice at the outset.
3. How do you claim tax deductions for a home office?
Did you know that you can use Bonsai for accounting? Or that Bonsai can help you be prepared for self-employment tax by providing tax estimates, filling date reminders, and identifying your tax write-offs?
Let's see how that works. First, head to your main Bonsai dashboard and have a close look on the left side - we'll be working with the bookkeeping and taxes sections. First click on "Bookkeeping".
Inside the bookkeeping section, you'll see a breakdown of your income and expenses. Both can either be automatically imported from your bank account, or manually added. Work you got paid for via Bonsai will also be registered here.
Make sure this section is properly filled in and click on "Taxes" next.
This is where the magic happens: Bonsai taxes will do all the calculations for you, and we'll provide you with an overview of your tax estimates, a list of tax deductions you can use for the upcoming tax season, and reminders for all the upcoming filling dates.
The IRS outlines two ways to claim tax deductions for a home office:
The simplified method: In which you don’t calculate or allocate actual expenses. Instead, you multiply the prescribed rate of $5 by the area of your home that’s used for business, which is limited to a maximum of 300 square feet. If you choose to use the home office simplified method, the only actual business expenses you can deduct are those that are not related to the use of your home, like pens and paper.
The actual expense method: In which you determine the percentage of your home used for business, and then divide the expenses of operating your home between personal and business use. You also have to figure out direct, indirect and unrelated expenses. This is a more complex way of claiming tax deductions for a home office.
Here are a couple of examples to explaIn the two methods.
In the simplified method, you take the square footage of your office, to a maximum of 300 square feet, and multiply it by $5 to get your deduction. That means you’ll get a maximum deduction of $1,500. But you don’t have to document expenses and keep records.
In the actual expense model, if you perform an upgrade to the office itself, such as paying a builder to make a partition or wall that forms the discrete office space, that could be considered a direct expense and could be used in full as a deduction.
But the cost of maintaining and running the entire home, such as home insurance and utilities, would be considered indirect and would be deductible based on the percentage of your home that’s used as a business space. And the costs for other areas of your home, like painting your kitchen, would be considered unrelated expenses and not eligible to use as a deduction.
Which method you choose could be dependent on the size of your office, the size of your business operation, and whether the time it takes to track those actual expenses is worth it in the end. You need to ask, would your tax deductions for a home office be greater than the $1500 of the simplified method?
4. What are the keys to tax deductions for a home office?
If you decide to take the actual expenses route, you’ll need to do some math to start, and then keep meticulous records of your home expenses.
First you’ll determine what percentage of your home is used as office or business space.
For instance, if your office is 200 square feet, and your home is 2000 square feet, the percentage dedicated to your office would be 10%: 200 square feet ÷ 2000 square feet = 0.10 (10%)
Then you’ll track the indirect expenses, against which you’ll apply the percentage to arrive at your tax deduction. Examples include:
Utilities and services, which includes electricity, gas, and municipal services like garbage removal.
You’ll also want to track direct expenses. Examples include:
Repairs or maintenance to the actual office space, such as painting it.
The cost of a special phone line (but not the cost of the first telephone line in your home).
The cost of long distance business calls and other direct business expenses.
You can also use mortgage interest and property taxes as tax deductions by converting part of them from personal itemized deductions to business deductions.
If you own your home, you may also be able to claim a deduction for depreciation. This is another consideration when deciding which method to use for claiming tax deductions for a home office. That’s because the depreciation is subject to capital gains tax if you sell your home.
If you use the simplified method, you may not be subject to that capital gains tax because depreciation doesn’t come into play with that approach.
Final thoughts about tax deductions for a home office
An important takeaway from all of this is that it’s best to keep records of all your expenditures, such as electricity bills, just in case the IRS ever questions your expenses. It’s the same as tracking other types of tax deductions, like office supplies, special software, business licenses and professional development costs, to name a few.
It’s also good to remember that whether you qualify for tax deductions for a home office is determined each year. While you may or may not be eligible this year, it could change in the next tax year, if your business situation changes, or you move your freelance business to a different office space.
And while it seems like a lot of math at the outset, if the situation remains the same, you should only have to do the calculations once, and enjoy the tax savings every year. If your office square footage remains the same, your business situation is constant, and your expenses are relatively consistent, it should become routine to file your taxes with the correct forms year after year.
Finally, don’t worry that claiming tax deductions for a home office will raise a red flag with the IRS. It's a myth the home office deduction will trigger an audit. Anyone can be audited at any time, but if you follow the rules and keep records, you should be fine. It’s best to take advantage of what’s provided to freelancers to boost your profits and lower your taxes.