Tax time is upon us all. Whether you’re completely self-employed or you simply do some moonlighting on the side, you should take note of an important change to the 1999 tax code on deducting expenses for the use of your home in your business—it may enable you to take your first home office deduction.
The home office deduction really can help you take a nice chunk of money off your net business income. Even if you don’t make much money on your freelancing, you should consider taking this deduction. Because self-employment income is taxed at a higher rate than employment income, you could save upwards of 40 cents on the dollar for doing some extra paperwork.
Prior to the 1999 tax year, the tests for deducting business use of the home were as follows:
- The home office must be used regularly and exclusively. In other words, your home office can’t be a corner of the family room.
- The home is your fixed place of business—you do all your work there. For example, if you’re a consultant and do most of your work at your client sites, you didn’t meet this test because the home office is not your “fixed” place of business.
With your 1999 taxes, the IRS has relaxed the second test. Now, the home office qualifies if it is where you conduct all administrative activities related to your business. If you use your home office to do things like make phone calls to prospective clients, research upcoming projects, and calculate your invoices, you can deduct expenses even if you produce your work at a client site. Of course, you still need to meet the first test for regular and exclusive use.
Getting the forms
You can download all the forms you need from the IRS Web site. The link http://www.irs.ustreas.gov/forms_pubs/findfiles.html will take you to the search page for the forms. Besides the obvious 1040 Form, you’ll need to file the following to take the home office deduction:
- Form 1040 Schedule C: Profit or Loss from Business (Sole Proprietorship)
- Form 8829: Expenses for Business Use of Your Home
If you deduct home expenses, you cannot use the Schedule C-EZ, popular with part-time freelancers because it’s simpler and designed for folks with less than $2,500 in self-employment income.
What you can deduct
If you meet the tests, you can deduct a portion of expenses relating to your home as a whole and 100 percent of expenses directly related to your office. For the first, figure out how much space is dedicated to your home office—your business percentage. One way to do this is by square footage (if your office takes up 300 square feet of a 2,000 square-foot home, that’s 15 percent). This method is encouraged on the form itself, but the instructions say that you can also base it on the number of rooms, if the rooms in your house are of approximately equal size. For example, if your office is one of six rooms, the percentage is 16 percent.
Expenses related to the whole house
You’ll use this business percentage to figure out how much of your home expenses as a whole to deduct. You can deduct that percentage of the following in the “Indirect Expenses” column of Form 8829:
- Mortgage interest
- Real estate taxes
- Repairs and maintenance
- Rent, if you don’t own your home (list it in the “Other Expenses” column)
You can deduct some other expenses as well; check the instructions.
The same list is used for expenses directly related to your office—you just enter the expense under the “Direct Expenses” column. The difference is essentially the part of the house for which the expense was incurred. If you repair water damage to the kitchen ceiling, that’s a home repair and you can deduct only the business percentage of the cost. If the ceiling in your office caves in, however, you can deduct 100 percent of the repair cost.
A few notes
If you decide to deduct home expenses, here are some closing tips:
- You can’t deduct improvements to your house in this way, only repairs and maintenance. Capital improvements must be depreciated.
- If your home business expenses exceed your self-employment income, you can’t use them to claim a loss. But you can carry over the difference to the next year.
- You can claim expenses only for that period in which you used the home for business. This means that if you didn’t start freelancing until October, you can only claim expenses for the last three months of the year.
- Last but not least, you can’t deduct it if you don’t document it. Fortunately, keeping track of your receipts becomes a lot easier once you find out how much money those little pieces of paper can save you at tax time.
Meredith Little has worn many hats under the broad term of freelance writer, including technical writer, documentation specialist, trainer, business analyst, photographer, and travel writer.