In 1986 I formed a practice providing accounting services and two years later added tax preparation to my practice. During the majority of the time since, I’ve operated my practice from home. There are several reasons why I chose to do so. My daughter was born in 1989 and I was fortunate enough to experience the heartfelt joy of watching her take her very first footsteps on her own. Then, there is the financial benefit of saving on operating expenses by not renting a commercial space for your business. I also enjoy the freedom of working in comfortable sweat clothes and the pleasure of listening to my music throughout the work day.
In addition, there are certain tax benefits in operating a business from home. I often joke that, not only do I not have additional overhead, but I have “underhead”. Here’s what I mean by that. Operating a business from home allows the owner to write off certain expenses related to maintaining a household. That includes mortgage interest and real estate taxes if the business owner is the owner of the home. These deductions are also available to anyone who owns a home regardless of whether or not they operate a business from their home. However, home-based businesses can also claim additional deductions for utilities, homeowner’s insurance and repairs performed on the home for which the business office also benefits. In addition, the business portion of the home can be used to claim depreciation. If improvements to the home such as a new roof or furnace are made, the portion of the improvements for which the business space benefits may also be depreciated. Business owners who rent their home may claim their rent expense. These latter deductions are not available to homeowners who do not operate a business from home. Therein lies the “underhead” claim.
The formula for determining the business use percentage is as follows: Calculate the square footage of the room or rooms used exclusively for business. This number represents the numerator in the formula. Let’s use 200 square feet as an example. Then, calculate the square footage of the entire home, omitting the square footage of hallways, closets and bathrooms.
For example, if the total square footage of the home is 2,000 and the area of the hallways, closets and bathrooms is 200 square feet, the entire square footage of the home is 1,800. That figure is the denominator in the formula. So, the business use percentage is as follows:
200 sq. feet (exclusive business use)
÷ 1,800 sq. feet (total applicable home sq. footage)
= 11.1% business use
This allows the business owner to deduct 11.1% of the afore-mentioned business expenses. On a federal tax return form 8829 is used to claim home office expenses. In addition to these expenses, you may deduct, in full, expenses for a separate telephone line used exclusively for business and that amount is entered directly on Schedule C. I don’t recommend entering home office expenses onto your business books because it’s easier to calculate them at year-end to be reported on Form 8829. You may refer to Form 1098 from your mortgage lender to determine your annual mortgage interest deduction. If you have an impound account to collect expenses for real estate taxes and homeowner’s insurance, these totals will also be reported on Form 1098. After entering the business portion and total square footage of your home on Form 8829, the total amount of home office deductions claimed on Form 8829 are reported in full on the indirect expenses section and flow through to Schedule C, provided that there is sufficient net profit to absorb them. Any disallowed home office expenses may be carried forward to subsequent tax years.
The Tax Benefits of Running a Home-Based Business