Do One Thing: Write off your home office (time: a few hours)

Kate Ashford  |  06:00 PM, Monday, December 6, 2010

Whether you’re running your Etsy side business out of a spare bedroom or self-employed and working full-time out of your home, you might have thought about taking a home office deduction. (Maybe you haven’t? Guess what. You should.) The good news is that it will save you cash on your taxes. The bad news is that the calculations can be a pain in the neck. Here’s the nitty gritty.

This is for you: If you use an area of your home “regularly and exclusively” for business. (That’s the IRS language, folks.)

Hands-on time: 30 minutes to a few hours. Depends on your comfort level with taxes and whether you do your taxes yourself or use a tax preparer.

Total time: Same

Cost: $0, although it may be more expensive to do your taxes (or have them done) if this is the first year that you’re filing as a business owner, which means you’re filling out a Schedule C. Tax software that includes Schedule C usually costs more, and tax preparers may charge more.

Can you deduct your home office?

• Did you make money? You must have net income (meaning you earned more than you paid in expenses) from your business. Otherwise, there’s nothing to deduct against. If you have no net income this year, the unused deduction can be carried over and used next year (presuming you have net income then).


• Do you have a designated space? You must be using an area of your home “exclusively and regularly” for business. Translation: You can’t deduct your living room just because you do some work on your couch. It’s possible to deduct only part of a room (for example, the literal square footage of a desk in the dining room), but it’s tricky.


• Do you use part of your home to deal with clients or store inventory? That also counts.


• Is it your principal place of business? If you have a storefront elsewhere and you’re only doing 15 percent of your work from your desk at home, it’ll be tough to make the case.


• Running a daycare? Totally different rules apply to you. You’re better off reading IRS Publication 587, “Business Use of Your Home.”

What you’ll need:

• Receipts. We can’t stress this enough. Keep all of your business-related receipts. For purposes of the home office, you’ll want to save receipts for furniture, insurance (homeowners or renters), and cleaning and repairs. (We’ll get into “direct”and “indirect” expenses farther down.)


• Cancelled checks and utility bills that act as proof of mortgage or rent payments and utility payments.


• If you’re claiming building depreciation (we’ll get to that), you’ll need the closing statement for your home plus proof of any improvements that have been made.


• Good tax software (such as TaxAct or Turbo Tax) or a good accountant. (Here’s how to find one.)


• The exact square footage of your home office (or home office area) and the total square footage of your home. If you use a desk (exclusively and regularly) in a larger room in your home, measure the square footage of the desk and a reasonable area around it for your chair.

What to do:

1. If you hire an accountant, she’ll tell you what she needs and do most of the work for you. (This is the easiest—but priciest—way to do this. However, it’s also usually the most foolproof—many people goof when they try to do the home office paperwork themselves.)

2. If you’re using tax software, you’ll want to use whatever software tackles business taxes, such as TurboTax’s Home & Business package. If you’re doing this by hand (and why, again, are you doing that?) you’ll need to file IRS form 8829 along with your Schedule C.

3. Organize your home office expenses into categories and enter them into the applicable spots on the form or in the tax software:

• Deductible mortgage interest and mortgage insurance premiums
• Real estate taxes
• Insurance (homeowners or renters, for instance)
• Rent
• Repairs and maintenance
• Utilities
• Other expenses

4. Calculate depreciation, if applicable. If you own your home, you can claim a depreciation deduction, which basically allows you to write off the cost of your house over time (or more accurately, the home office portion of it). You can only claim depreciation on the building, not the underlying land. Standard practice is to claim that 20 to 25 percent of your purchase price was for the underlying land, but you may have to check your mortgage closing statements to be sure. (If you own a condo or town home, the percentage is closer to 5 percent.) If you want to read more about depreciation deduction, click here.

5. Tax software and worksheets will ask for direct and indirect expenses. Direct expenses benefit only the home office (repairs, etc.). Indirect expenses benefit your entire home, such as electricity, water, insurance, and maintenance fees.

6. We recommend tax software (at the very least), since it will guide you through your home office deduction questions and offer help if you need it. But if you want to work out the numbers yourself, you’ll find a worksheet on page 26 of the IRS’s publication 587, “Business Use of Your Home.” (Don’t get overwhelmed – there are instructions on the next page.)

To learn more:
Work from home? Deduct your home office. (Bankrate)
Should I Use an Accountant? (LearnVest)
The Tax Traps of Working at Home (MSN Money)

Who helped: Charles Smith, C.P.A. and M.S.T., partner at Smith & Associates in Chicago

Did you do it? Tell us what worked or share other tips and links in the comments below.