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One of the tax benefits of self-employment is the ability to take advantage of the home office deduction. But there are some limitations and requirements that must be met. In order to determine if taking a home office deduction is smart, let’s look at the pros and cons.
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With remote working now widely-accepted—and, in fact, historically considered a return to our roots—one of the tax benefits of self-employment is the ability to take advantage of the home office deduction. But there are some limitations. To qualify for a deduction, an individual must satisfy two requirements: 1) the space used in the home must be used exclusively and regularly for business purposes; and 2) it must be the principal place of the business. Per the Tax Cuts and Jobs Act of 2018, the ability for employees who telecommute to take a deduction for home office expenses was eliminated.
Before we explore the benefits and disadvantages of taking this deduction, it’s important to note that the expenses cannot create a loss for a business (i.e., the deduction can only be taken if the business shows a profit after subtracting the deduction amount).
Pros of a Home Office Deduction
- Home expenses that are normally not tax deductible, such as utilities, may be partially deductible from ordinary income.
- Expenses that may be itemized deductions on a personal tax return can partially be used as home office expenses, saving taxes in a situation where a taxpayer’s itemized deductions may be limited because of adjusted gross income thresholds.
- The portion of a home that serves as an office can be a depreciation expense, potentially lowering current income taxes.
Cons of a Home Office Deduction
- The calculation of the appropriate amount allowed as a deduction can be complex and time-consuming.
- Taking the deduction has significant tax consequences when a taxpayer sells his or her primary home. When a taxpayer sells a primary residence on which the deductions have been taken, the portion of the residence that was used as a home office is excluded from capital gains exclusion afforded the sale of a primary residence ($250,000 single, $500,000 married, filing jointly). The portion of the gain attributable to the home office use would be subject to capital gains taxes, which may result in a tax bill higher than any savings the homeowner may have seen from the home office deduction, depending on the size of the capital gain.
This so-called home office trap can be avoided by not taking the deduction or by using the simplified method for calculating a deduction, which allows a taxpayer to deduct $5/square foot, up to 300 square feet.
Individuals contemplating taking a home office tax deduction are advised to talk with their tax advisor, who can guide them through this very complicated and important tax decision
Please reference disclosures: https://blog.americanportfolios.com/disclosures/
FAQs
You can claim a home office deduction if both of these apply: You use your home exclusively and regularly for administrative or management activities of your trade or business, and. There's no other fixed location where you conduct substantial administrative or management activities of your trade or business.
What are the disadvantages of home office deduction? ›
The drawbacks of the home office deduction
A taxpayer can only use the deduction to offset profit. If the business has generated a loss, the deduction may not be available.
Should I use the simplified home office deduction? ›
Is it a good idea to use the simplified home office deduction? Only if the deduction you could obtain using the regular method isn't much more than $1,500. Most people with home offices, particularly those who rent their homes, can qualify for a home office deduction much larger than $1,500.
Does having a home office help with taxes? ›
The home office deduction allows qualified taxpayers to deduct certain home expenses when they file taxes. To claim the home office deduction on their 2021 tax return, taxpayers generally must exclusively and regularly use part of their home or a separate structure on their property as their primary place of business.
Can I write-off my internet bill if I work from home? ›
The internet makes it possible for you to run your own business, and without it, your business wouldn't exist. You can deduct internet costs if you work from home or regularly do business online. Running a business online can include: Acquiring new business or customers through various platforms.
How much of my home office can I claim on taxes? ›
This deduction is limited to no more than $1,500 and is calculated by multiplying the square footage used exclusively for the office, by 5 dollars. If you use this simplified option, just know that you cannot deduct any other expenses related to the home, or the home office, such as utilities.
Can home office deduction increase a loss? ›
Second, you can only take the home office deduction up to your total net business income—you can't use the home office deduction to create a loss in your business. For example, if your net business income is $5,000 and your home office expenses are $7,000, you can only deduct $5,000 of those $7,000 in expenses.
Can you write-off your house if you work from home? ›
An individual is not entitled to deduct any expenses of using his/her home for business purposes unless the space is used exclusively on a regular basis as the “principal place of business.” The IRS applies a 2-part test to determine if the home office is the principal place of business.
Why do I not qualify for home office deduction? ›
If you're an employee working remotely rather than a business owner, you unfortunately don't qualify for the home office tax deduction (however some states do allow this tax deduction for employees).
Do I have to depreciate my home for home office deduction? ›
Depreciation allows for your property's decrease in value due to normal wear and tear. If you claim home office expenses using the actual expense method, you deduct depreciation if you have profit. Under the safe harbor method, you don't.
If you use your home office for your W-2 job and your side gigs, you won't be able to claim your home office as a tax deduction. The IRS allows you to deduct expenses for having a dedicated space where you regularly and exclusively conduct your self-employed business.
How to calculate utilities for home office? ›
Separately, multiply the number of working days in the month by the total square footage of your workspace. Divide your total bills by the first total space and total month number. Then, multiply that by the second total workspace and total workday number. That's how much of your utilities have been work expenses.
Can you write-off electricity if you work from home? ›
If you're a regular employee working from home, you can't deduct any of your related expenses on your tax return. In the past, you could claim an itemized deduction for unreimbursed business expenses, including expenses for the business use of part of your home if they exceeded 2% of your adjusted gross income.
Can you switch between simplified home office to actual? ›
A. Yes. You may elect to use either the simplified method or the standard method for any taxable year. However, once you have elected a method for a taxable year, you cannot later change to the other method for that same year.
How much of my cell phone can I deduct for business? ›
If you're self-employed and you use your cellphone for business, you can claim the business use of your phone as a tax deduction. If 30% of your time on the phone is spent on business, you could legitimately deduct 30% of your phone bill.
Can home office deduction create a loss? ›
Second, you can only take the home office deduction up to your total net business income—you can't use the home office deduction to create a loss in your business. For example, if your net business income is $5,000 and your home office expenses are $7,000, you can only deduct $5,000 of those $7,000 in expenses.
