Save Money With a Home Office

     If you are self-employed and working from home, you can reclassify some of your personal expenses to business expenses, unlocking worthwhile tax benefits.

     I often get asked whether you have to dedicate a whole room as a home office to claim the tax deduction. You don't. If you are self-employed, a freelancer, independent contractor, or small business owner, you can designate part of your home as a home office. W-2 wage earners typically don’t qualify, because the home office deduction cannot be claimed for activities related to the W-2 job, but if you also have rental properties, for example, you can claim the benefit.

     Each case is unique, so be sure to check in with your tax accountant to review the specifics for your industry and your situation. Generally, these are the requirements to claim a home office.

• Exclusive Use – The area you designate can only be used for business (it cannot double as your guest bedroom, for example).
• Regular Use – Occasional or incidental use doesn’t meet the requirement.
• Principal Place of Business – It must be the principal place of business for the self-employed activity, the place where administrative and management activities occur.
• Separate Structure – If the home office is in a separate structure from the main house, such as a detached studio, the whole space must be used exclusively and regularly for business.

     So, your home office can be as small as the three-square-foot area of a desk and computer, tucked into a corner of a bedroom as long as that area meets the requirements above.

How to Calculate Square Footage

     The benefits of a home office are based on its size relative to your home, so it’s important to calculate this information correctly. It’s easy to get it wrong, and this can cost you money. Many people measure the office space and compare it to the exterior dimensions of the house. This will reduce your benefit. The IRS says to compare your office square footage to the sum of the interior space of the rooms in your home minus hallways, closets, and stairways.

      Let’s take a 1,200-square-foot, 3-bedroom, 2-bath home. Strip out hallways and closets, and you're left with roughly 1,000 square feet of actual room space. Use the smallest bedroom, a 10x10, as your office. That's 10% of the house.

The Benefits Add Up Fast

     Once you qualify, you move deductions from property taxes and mortgage interest to your Schedule C, removing some of the limitations that apply to personal deductions.

     You can also deduct a percentage of your utility bills, including water, gas, sewer, electric, garbage, and internet. Maintenance costs like landscaping, paint, roof work, and carpet become partially deductible too.

     In the example above, if your office represents 10% of your home’s overall square footage and your utilities add up to $400 a month; that’s $5,000 a year. At 10%, you just earned another $5,000 in deductions, saving you roughly $2,500 a year in taxes.

     On top of that, you can depreciate a portion of your home's improvement value. On a $300,000 home, that 10% office share might allow you to depreciate $3,000 a year.

     But the biggest benefit, given recent gas prices, is what happens to your commute. Normally, driving from home to your office in town is considered non-deductible commuting mileage. Once you have a qualifying home office, that same drive becomes deductible business mileage, because you're now traveling between two business locations.

     If you live five miles from your office, that's 10 miles round trip or about 2,500 miles a year. At current IRS mileage rates, that's about $1,850 in deductions for money you were already spending on gas but couldn't write off. If you're commuting a longer distance, say from Willits to Ukiah, that deduction can approach $10,000 a year. When you add state and federal tax rates, the commuting benefit alone can save you anywhere from $1,000 to $5,000 a year.

The Bottom Line

     If you qualify for home office tax deductions but aren’t taking advantage of them, start today. Your tax accountant can help you with all the details.

     If you have questions about property management or real estate, please contact me at [email protected] or call (707) 462-4000. If you have an idea for a future column, share it with me and if I use it, I’ll send you a $25 gift certificate to Schat’s Bakery.

     Dick Selzer is a real estate broker who has been in the business for more than 50 years. The opinions expressed here are his and do not necessarily represent his affiliated organizations.