Man working on laptop in home office
Running a home-based business can offer tax deductions on home repairs in addition to typical business expenses. — Getty Images

The global coronavirus pandemic has had a major impact on businesses across the country by forcing many people to work from home until the situation improves. However, for some small business owners, the transition to working in a home office has proven efficient and cost-effective, prompting many entrepreneurs to consider making work-from-home orders permanent.

If you have created a dedicated space in your home that you use for business, you may be able to claim it and some of your home expenses on your tax return — as long as you meet the IRS requirements for a home office deduction.

The ‘exclusive use’ test

Broadly speaking, you must be able to show that a portion of your home is your principal place of business, and that this space is regularly and exclusively used for conducting business. If you do not have a dedicated space for business in your home, you are not allowed to take the home office deduction. The IRS refers to this as the “exclusive use” test.

For instance, a spare room in your home that is only used as your business office can be claimed for the home office deduction. However, a bedroom or living room where you work on business tasks cannot be claimed, because you use those spaces for other personal purposes.

There are exceptions to the "exclusive use" test, including businesses that store inventory or product samples, or use their home as a daycare facility.

Additionally, you must be a registered business owner or independent contractor to take the home office deduction. You cannot take the home office deduction if you simply work from home as an employee of another business.

What can I deduct from my taxes as a home-based business?

The following list contains the most common deductions home-based business owners claim on their tax returns. Consult with an accountant or financial professional to determine whether you are eligible for any of these deductions, as well as any others that exist outside this list.

Home-related expenses

Home office-related deductions are based on the percentage of your home that you use for business. To obtain this number, divide the square footage of your office space by the total square footage of your home. It is important that these calculations are accurate and that you only deduct the appropriate percentage of each expense.

If you do meet IRS guidelines, you can deduct the following home-related expenses:

  • Homeowner's insurance.
  • Homeowners association fees.
  • Cleaning services or cleaning supplies used in your business space.
  • Mortgage insurance and interest.
  • Utilities, including electricity, internet, heat and phone.

Repairs and maintenance

If you make home repairs or upgrades related directly to your business space, you may also write these expenses off on your taxes.

The amount you can write off depends on whether the expense is

  • Direct, which means that it only benefits your home office, or
  • Indirect, offering a benefit to your entire home.

NOLO breaks down the difference between direct and indirect office repairs:

Direct: If you spend $100 to fix a window in your home office, you may deduct the full $100 on your taxes.

Indirect: If you pay $1,000 to repair a leak in your roof, you may only deduct a percentage of that expense equivalent to the percentage of your home used for business.

You may also be able to deduct expenses for long-term improvements to your home, such as a full roof replacement or room renovation, but these must be depreciated over time. Repairs, on the other hand, can be wholly deducted in a single tax year.

While the IRS rules about home office deductions are very strict, it's not automatic that you will get audited simply for claiming your home office.

Other business expenses

To qualify as deductible, a business expense must be considered both ordinary and necessary, meaning the expense is common and helpful for your trade or industry. The following expenses may be deducted on any home-based business tax return, regardless of whether you are eligible for the home office deduction:

  • Cost of goods sold. If your business manufactures products or purchases them for resale, you can include some of your expenses to calculate the cost of goods sold. The following expenses can be figured into the cost of goods sold: storage, factory overhead, direct labor costs and the costs of products or raw materials, including freight.
  • Capital expenses. Capital expenses are costs that you are required to capitalize, rather than deduct, because they are a part of your investment in your business and are, therefore, considered a business asset. In general, the three types of costs you can capitalize are business startup costs, business assets and improvements.
  • Business use of your car. If you use your car as a part of your business, you are allowed to deduct certain car expenses. As with home expenses, the vehicle use for business deduction must be calculated based on the percentage of miles driven for business purposes, versus personal trips.
  • Employee payments. Generally, you can deduct the cost of paying employees.
  • Retirement plans. This type of savings plan offers tax advantages when you and your employees set aside money for retirement.
  • Rent expenses. According to the IRS, rent is any amount you pay for the use of property that you do not own. Rent deduction is only applicable if you do not and will not receive equity in or title to the property.
  • Interest. If you borrowed money for business activities, you may deduct the interest expense.
  • Business taxes. You are allowed to deduct various federal, state, local and foreign taxes that directly affect your trade or business.
  • Business insurance. You can deduct insurance as a business expense if it is both ordinary and necessary for your trade, business or profession.
  • Meals and entertainment. Generally, you are allowed to deduct 50% of any business-related meal and entertainment expenses.
  • Travel expenses. You can claim a deduction for travel-related expenses if you reimburse them under an accountable plan.
  • Supplies and materials. You can generally deduct the cost of business-related supplies and materials consumed and used within a tax year.
  • Professional services. Fees incurred from professional services that are ordinary and necessary, such as accounting, consulting, legal or contract labor, can be deducted as a business expense.
  • Marketing and business development. Generally, expenses that are used to find new customers and keep existing clients can be deducted.

The IRS provides a detailed explanation of these types of expenses and what is eligible for deduction.

Will I get audited by the IRS if I take the home office deduction?

It is a common belief is that claiming the home office deduction will automatically trigger an IRS audit. While the IRS rules about home office deductions are very strict, it's not automatic that you will get audited simply for claiming your home office.

Ascension explains that, because of the ever-increasing number of home offices, "tax officials cannot possibly audit all tax returns containing the home office deduction."

Regardless, if you do decide to take the home office deduction, it's essential to follow the IRS guidelines to the letter.

Accounting tips for home-based businesses

Accounting is incredibly important for any business, but home-based business owners will need to pay special attention to their finances and expenses if they want to save the most money during tax time.

Here are a few key tips to exercise throughout the year in preparation for tax season:

  • Create a separate space for your business. If you want to take a home office deduction, ensure your workspace meets the “exclusive use” test.
  • Separate business and personal expenses.Maintaining distinctly separate accounts for business finances and personal finances will keep your books clean and organized when you need to evaluate your business income and expenses.
  • Track all business use of personal assets.If you use assets like your laptop, cell phone and car for both business and personal purposes, be sure to keep a record of any business use so you can accurately calculate the percentage used for business.
  • Account for estimated and self-employment taxes. Unlike a traditional job in which an employer withholds taxes, Social Security and Medicare payments from an employee’s check, business owners must pay these expenses. Sole proprietors, partners, LLCs and S corporations are generally required to pay estimated quarterly taxes.
  • Hire an accountant. You can learn a lot about accounting and tax regulations through independent online research, but there's no substitute for the advice of an experienced professional. Follow our guide to choosing an accountant if you're looking for the right CPA or accounting firm for your business.

Coronavirus-related tax information

The U.S. federal, state and local governments have taken several measures to lessen the impact of COVID-19 on businesses and to reduce the impact on the economy. If your business has been impacted by the coronavirus pandemic, the following information can help you find tax relief or emergency funding.

The CARES Act

The Coronavirus Aid, Relief, and Economic Security (CARES) Act is a $2 trillion stimulus bill that was signed into law on March 27, 2020, to slow the economic downturn caused by the global coronavirus pandemic. The CARES Act is the largest financial support package in U.S. history and was designed to support businesses large and small, individuals, families, independent contractors and hospitals.

Employee Retention Credit

The employee retention credit is a refundable tax credit for qualified wages paid to retain employees between March 13 and December 31, 2020. The goal of this credit is to incentivize employers to keep employees on the payroll, even if they are not working. The credit provides up to $5,000 refundable credit for each full-time employee you retain during this timeline.

Your business qualifies for this credit if you were ordered to partially or fully shut down, or if your business experienced a significant decline in gross receipts (over 50%) when compared against the same quarter in 2019.

It’s important to note that while the Paycheck Protection Program was also funded, you could not take advantage of both the PPP and the Employee Retention Credit simultaneously.

Paycheck Protection Program

As part of the CARES Act, the Paycheck Protection Program (PPP) appropriated $349 billion to help small businesses maintain payroll and take care of other overhead expenses caused by the coronavirus.

The PPP applied to businesses, nonprofit, veteran and tribal organizations that employed fewer than 500 workers or fall under the Small Business Administration Standard. These organizations were eligible for a Small Business Interruption loan up to 2.5 times their average monthly payroll up to $10 million. Funds procured from this loan may be used to cover rent, utilities, payroll, benefits, salaries and interest payments. All fees were waived, and the loan did not require collateral or a personal guarantee.

PPP applications were suspended on April 17, 2020, and are pending additional funding for the program.

Economic Injury Disaster Loans

Finally, the Economic Injury Disaster Loans (EIDL) have been expanded to provide up to $10,000 in emergency relief for small businesses affected by the coronavirus. This loan does not have to be repaid and, for other EIDL loans, you can borrow up to $200,000 without providing a personal guarantee.

CO— aims to bring you inspiration from leading respected experts. However, before making any business decision, you should consult a professional who can advise you based on your individual situation.

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Published March 28, 2019