You’ve been making a go of your business right from your home. Maybe the pandemic made you consider it, or perhaps it was something you were always working toward. It makes sense for so many different types of business, from digital agencies to fine art and more. As we enter April, you may be wondering if there are any tax deductions you’re missing. While home mortgage interest, real estate taxes, utilities, maintenance, rent, depreciation, and property insurance are not deductible business expenses, we suggest a few deductions that can work for you!
Tax Deductions For Home Offices And Businesses
Exclusive Use Test and Regular Use Test. A key guideline that determines whether a home office tax deduction is acceptable for your home-based business is called the Exclusive Use Test by the Internal Revenue Service (IRS). According to the test, you must use a specific area of your home only for business. Meaning it is a separate room or space. The space doesn’t need to be marked off by a permanent partition, but you won’t pass the IRS Exclusive Use Test if the area is used for both business and personal purposes.
If your home business’s work location in your home passes the Exclusive Use Test, then you can proceed to deduct the related expenses on Form 1040 or Form 1040-SR. There are a few exceptions to the Exclusive Use Test. If you use part of your home as a daycare facility, or if you sell products as your business and you store your inventory in a separate space in your home exclusively, you automatically pass the test.
The Regular Use Test is similar. If you have an area of your home exclusively for your business’s use that passes the Exclusive Use Test, that doesn’t necessarily mean you use it regularly. The Regular Use Test ensures that you use your home business area often—more than once or twice a month, for example.
Calculate the Deduction for Home Expenses. To make this calculation, you’ll want to figure out the percentage of your home that you use for your business. Measure the area you have dedicated to your business work and divide that square footage by the total square footage of your home. Multiply that answer by 100, and you have the percent of your home used for your business. What do you do with that information? Use this percentage to claim a portion of these expenses:
- Utilities like internet, heating and cooling, phone, and electricity.
- Homeowner’s insurance.
- Mortgage insurance and interest.
Home repairs. Can you deduct home repair work as a business deduction? Possibly. If the repair work was performed directly in the area you use for your business, absolutely! If the repair work was not done in your home office area, but it indirectly benefits your home office or allows your home-based business to continue, use the calculated percentage for deduction in the previous section to determine what percentage of the repair cost can be deducted.
Eligible business deductions unrelated to home offices. There are more deductions for some home-based businesses to consider depending on how the business operates. These include:
- Business use of your car. Calculate how much your vehicle is used for your business compared to other uses to determine the deduction amount. This is figured as miles driven.
- Storage costs for goods you sell.
- Business loan interest.
- Business insurance costs if the insurance is necessary and considered ordinary in your industry.
- Supplies. If the supplies are for the exclusive use of your business, the year’s worth can be deducted. Make sure you have good records!
- Fees for common business professional services like accountants, lawyers, and contractors.
- Expenses to find new customers and retain current customers.
Will you get audited? The IRS is notoriously strict when it comes to home office deductions. That does not mean they automatically trigger an audit. The potential for an audit is an excellent reason to make sure your records are kept to substantiate your deductions. You can reduce the likelihood of an audit by making sure your deductions are ordinary and common to other home-based businesses like yours. Your taxes will be compared to similar businesses. For example, an audit could be triggered if you claim your home-based business exclusively uses a much higher percentage of your home than comparable businesses.
Consult an expert. Are there good opportunities for home-based business tax deductions? Absolutely. The IRS sometimes changes its guidelines, though, which can be challenging to track. It is a good idea to have an accountant review your deductions plan or do your taxes for you, especially if you have significant concerns about being audited. Nothing beats a professional!
Be prepared for next year. Here are some tips to consider to make next year more manageable.
- Separate your business expenses from your personal expenses. Have separate accounts for your business.
- Track business use of your car, laptop, and phone. For example, keep track of the miles used exclusively for business and hours used on your computer for business.
- Create a separate space for your business so you can pass the Exclusive Use Test easily.
While this information is not exhaustive, we hope it helps get you thinking about how you can maximize your opportunity for tax deductions for your home-based business.
Editor's Note: Are you an independent contractor looking for some tax deduction tips? Check out this blog post with 10 deductions for independent contractors.
