Tax Savings of a Home Office

Maximizing Your Business Deductions – Part 1

Establishing a Home Office

If you are in business for yourself (such as a partnership, sole proprietor, LLC, or a subchapter “S” corporation), and you run your practice in a location other than your house, you should seriously consider setting up an office in your home to maximize your bona fide business deductions.

The IRS, in publication 463 states: “If you have an office in your home that qualifies as a principal place of business, you can deduct your daily transportation costs between your home and another work location in the same trade or business.”

The only rule is that you have to set up your home office and use it regularly and exclusively to administer your business. This means that you can’t use this office space for a guest room, or for viewing tv/cable/video, or allow your children to do their homework in it. It must be used solely to conduct your business. If you have a spare den or bedroom, or want to build an office in your basement, this can produce savings for you on several levels.

If you are in the 25% tax bracket, you would save $1,545 in income taxes, plus $945 in self-employment taxes (15.3%), for a total tax savings of $2,490. Of course your individual savings would depend upon your actual costs and your tax bracket, but you can see that you will save you a considerable amount.

First, driving from your home to your “other” office is now business travel, not commuting. The deduction for 2012 is $.55/mile. If the distance between your home and other office is 10 miles, then each day you go to your other office means you get an $11 tax deduction. If you work only 200 days a year, that translates to a $2200/year deduction. [Note: If you are not using mileage, but actual costs, the shifting of mileage from commuting would significantly increase the business percentage of the costs, especially if you are leasing or making payments on the car, or depreciation…]

Second, you get to deduct a percentage of your home’s operating costs. This is determined by the number of square feet of your office divided by the total square footage of your home. So, if your office is 10% of the total square footage, then you get to deduct 10% of costs such as:

  • Rent (or mortgage)
  • Utilities (heat, electricity, water, alarm, garbage, internet, sewer, etc.)
  • Insurance (homeowners – be sure to inform your insurance agent that you have a home business – or renters)
  • Property taxes (if you own)
  • Maintenance and repairs (including housecleaning, cleaning your windows, gutters, and roof, and repairs to house)
  • Direct Expenses used solely for your business, such as installing internet in your office, furniture, computers, file cabinets, telephone, other equipment, etc.

So, let’s see what this might save you. Assuming that you are paying the following costs to operate your home:

 

 Proportional Costs
 Mortgage or rent  $18,000
 Utilities  $3,600
 Homeowner’s Insurance  $1,000
 Property Taxes  $5,000
 Maintenance/Repairs  $4000
 Total  $31,600

 

 Direct Costs
 Mileage (2000 @ $.55)  $2,200
 Equipment  $1,000
 Total  $3,200

 

Assuming that your office represents 10% of your square footage, you would be able to deduct $3,180 as your proportional costs, plus your direct costs of $3,000, for a total deduction of $6,180.

If you are in the 25% tax bracket, you would save $1,545 in income taxes, plus $945 in self-employment taxes (15.3%), for a total tax savings of $2,490. Of course your individual savings would depend upon your actual costs and your tax bracket, but you can see that you will save you a considerable amount.

Now the question is how do ensure that you qualify. Remember that in addition to the home office being used exclusively for your business, you must show evidence of such, especially when you want to be able to deduct the mileage between your home office and your other office. We all take some work home.

So, every day, before leaving home to go to your “other” office, you go to your home office and log on to your computer, and answer and send e-mails regarding your business. As long as you don’t delete your messages you have a log of business activity. Upon your return, again, go on your e-mail and read/write e-mails. You also should enter into your business calendar when you are home working on issues such as appointments, billing and bookkeeping, writing reports, ordering supplies and such.

One last item of note: If you own your home, and have a home office, talk to your tax advisor about issues of deducting depreciation, as when you sell your house you would have to pay taxes on the recaptured depreciation you’ve deducted (which would work in your favor as inflation reduces your tax bill…).

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