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Expand your home office deductions with ‘rooms method’

by on
in Small Business Tax Deduction Strategies

If your main workplace is your home, you may be able to deduct expenses attributable to the part of the home used for business purposes. Normally, these “everyday expenses” are personal and completely nondeductible, but you can deduct a portion based on the home’s percentage of business use.

Strategy: Use the business percentage method that gives you the biggest deduction. In other words, you don’t have to rely on the IRS-prescribed method on Form 8829, Expenses for Business Use of Your Home. You’re free to use any other “reasonable” method.

Here’s the whole story: To qualify for home office deductions, you must use a separate area of your home regularly and exclusively as your principal place of business or as a place where you meet or deal with customers, clients or patients in the normal course of business. Alternatively, you may deduct expenses in connection with a separate structure (e.g., a detached garage) used for business.

If you’re an employee, the home office must be used for the convenience of your employer.

Generally, you can deduct direct expenses, such as a PC for your office, and a proportionate share of indirect expenses such as mortgage interest, property taxes, utilities, repairs and insurance. (Of course, mortgage interest and property taxes would be deductible anyway.)  Plus, you get a depreciation deduction for the portion of the home used as an office.

Typically, on Line 3 of Form 8829, you’ll enter the business percentage of your home office based on square footage. For instance, if you use a spare bedroom for a home office that is 280 square feet and there is a total of 3,500 square feet in your house, the percentage for home office deductions is 8%.

However, in the Form 8829 instructions, the IRS says you can use any reasonable method for determining the percentage of business use of your home. One common technique is to base the percentage on the number of rooms in your home when the room sizes are comparable. Check to see if this “rooms method” increases your home office deduction.

Example: Let’s go back to your house with 3,500 square feet. Assume that the home has eight rooms—kitchen, family room, living room, dining room and four bedrooms—plus 2½ bathrooms, a mud room, a basement and a garage. In addition to $7,500 of direct expenses for your home office, you have $5,000 in indirect expenses that must be allocated according to the business percentage. Also, you’re entitled to a 4% depreciation allowance on your home’s structure with an adjusted basis of $500,000.

If you use the standard square-footage method, you can deduct 100% of your direct expenses ($7,500), 8% of your indirect expenses ($400) and a depreciation allowance of $1,600 ($500,000 x 4% x 8%) for a total deduction of $9,500.

Now let’s see what happens if you base the business use percentage on the number of rooms. Since you use one room as an office in an eight-room home, the applicable percentage is 12.5%. You still deduct $7,500 in direct expenses, but your indirect expenses increase to $625 ($5,000 x 12.5%) and your depreciation allowance jumps to $2,500 ($500,000 x 4% x 12.5%). Your total deduction on Form 8829 is $10,625—$1,125 more than before.

In any event, your home office deductions for the year cannot exceed the gross income from the business minus business expenses (other than home office expenses). Any excess may be carried over to future years.

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