Expenses for Business Use of Your Home
One of the advantages of owning one’s own business is the deductibility of expenses which would otherwise be considered personal, and therefore not deductible, for income tax purposes. Three of the most common expenses which are generally not deductible for income tax purposes are rent, utilities and insurance. However, if an individual engages in a business for profit and meets the following two requirements, these expenses become deductible (in part) for purposes of determining the taxable income from that business:
1. The area (or room) must be used regularly and exclusively for administrative or management activities of the business, and
2. There is no other fixed location where substantial administrative or management activities are conducted.
What exactly does this mean? Assume you have a job where you’re an overworked and underpaid employee. Every day of your work schedule you travel to the location where you conduct your work. This is generally in a building in an office or cubicle. Every day of your work schedule constitutes “regular” use of this area. Whether you work four hours a day or ten hours a day is irrelevant. The fact that you do this on a scheduled basis satisfies the regular use requirement. So what does exclusively mean? In your work area, do you take naps, watch television, or conduct other activities not related to your work? Chances are, you do not. At least not for long. Since this area is used solely for the purpose of conducting your work activities, the requirement of exclusivity is met. If there is no other fixed location where you conduct a substantial part of your work activity, requirement 2 is met. Obviously, the business owner in this case gets to deduct the cost of rent and other expenses of the property. If the business owner owns the building where this office space is located, they would be entitled to deduct the cost of the building over a period of years. This allocation of cost is known as depreciation. Of course there are other costs such as occupancy costs, insurance, maintenance and repairs, etc.
Consider this. Though you are still paying rent or other housing costs, utilities and insurance on your home, those expenses are not deductible for income tax purposes. Wouldn’t that be nice if they were?
Well, they can be. Let’s apply the above scenario to your own business which you operate from a room in your home. Every day, every other day, or whatever schedule you establish, you conduct business in this room. This might include calling customers, prospects or vendors, placing orders, completing paper work, etc. You have no other place where you can conduct these activities. You perform these activities two to four hours on each of your scheduled days. No other activities such as taking naps, watching television, etc. are conducted in this room. Your expenses for rent, utilities and insurance are now deductible for income tax purposes. By simply engaging in an activity with a profit motive and conducting the majority of that activity in this room, you now have expenses that are deductible for income tax purposes that would otherwise not be deductible.
The expenses for business use of your home are calculated under one of two methods: actual expenses or the simplified method. Both methods require that the square footage of the room or area be determined and the total area of the home be known. By dividing the square footage figure by the total square footage of the home, we derive the business use percentage. Let’s say we have a room which is 10′ by 10′, or 100 square feet. Let’s also assume the total square footage of the home is 1,000 square feet. Our business use percentage would be 10%, or 100 square feet divided by 1,000 square feet. Let’s further assume we pay rent in the amount of $500.00 per month. For each month we continue operating our business and meet the requirements discussed previously, we can deduct $50.00 of the rent as an expense for business use of your home. Of course, you may have other expenses as well in operating your business which are also deductible such as advertising, vehicle mileage (commuting to a job is not deductible), telephone, etc.
If you’d like more information on how you can start a business and take advantage of these and other tax deductions, complete the form below.
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