Zero cost federal tax deduction — business use of your home.

by Joe Heinrich, Certified SCORE Mentor

Nirvana would be that a small business owner could generate a deduction from her/his business’s taxable income at no cost. Well, that situation is available for many small business owners: the business use of the home deduction. However, not all of small business owners are taking advantage of this deduction due to not knowing about it or fearing that taking the deduction will trigger an IRS audit.

First, the facts. IRS regulations allow a business owner to take a deduction for the business use of the home, provided that the space is used “exclusively and regularly” for business purposes. The space can either be a room, a part of a room, a closet, the basement or garage, or a separate building on the home’s lot. 

The deduction is calculated by taking all the costs associated with the home and multiplying it by the percentage of square footage used for business purposes to the total square footage of the home. If the home is rented, the normal costs are rent, insurance, utilities, and repairs and maintenance. If the home is owned by the business owner, the normal costs are mortgage interest, real estate taxes, insurance, utilities, repairs and maintenance and depreciation.

Let’s take the following example: Assume a business owner’s principal place of business is her home. She uses a spare bedroom as her office that has a space of 200 square feet. The total area of her home is 1,000 square feet. Since she rents her home, her total costs for rent, insurance, utilities and repairs and maintenance are $30,000 annually. Based on these facts and assuming her business has taxable income, she can claim a deduction for business use of her home of $6,000 – and it doesn’t cost her anything!!!

Some small business owners don’t take this deduction because they do not know it’s available to them. Our job, as SCORE mentors, is to ensure that our clients who use their home as their principal place of business take advantage of this no-cost deduction. The simplest way to find out if the client is taking advantage of this deduction is to ask.

Some small business owners don’t take this deduction for fear it will trigger an IRS audit. The key to avoiding an audit is for the business owner to be truthful and reasonable about the area of the home used for business purposes. Based on my experience, I have not seen any disallowance of a deduction for business use of the home where the business owner was truthful and reasonable in determining the deduction.

There are some aspects about taking this deduction to which the business owner needs to be attentive:

  • Businesses that are taxed as partnerships and S-Corporations need to pay the business owner for the amount of the deduction. Such reimbursement needs to be completed prior to the end of each year. Such payment is not taxable income to the business owner.
  • Taking depreciation in the calculation of the deduction should only be done if the business owner does not plan to sell his/her home in the foreseeable future (i.e., at least in the next 5 years). This is because any depreciation that was part of the deduction calculation will need to be “recaptured” as ordinary taxable income at the time of the home’s sale.

Greater Seattle SCORE has a workshop that’s entitled “Saving Taxes for Small Businesses” that is presented monthly. This workshop describes in more detail the business use of the home deduction along with other Federal tax saving strategies that many business owners can implement.

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