Everyone that wants to be audited, please raise your hand.
Simply mention the phrase “home office tax deduction” and most people instantly think of an audit.
To say there is quite the stigma surrounding taking a home office tax deduction would be an understatement. On one hand, many individuals assume if they claim deductions for using part of their home for business purposes that they will automatically incur the wrath of an IRS audit. On the other hand, being able to write off a bunch of legitimate costs is extremely tempting and could save business owners and their employees a lot of money at tax time.
So should you use the tax deduction from running your business out of your home? What can you claim and what are the risks?
How to Stop Fearing the Home Office Tax Deduction
Here’s the thing: if you have a dedicated space in your home that is used only for business you have every right to deduct a portion of your rent/mortgage, utilities, security, and other associated home costs. Those deductions are part of the Internal Revenue Service code and not taking them is letting the government have more of your money that it deserves.
There are two keys to doing the home office tax deduction correctly:
Make Sure Your Deductions are Legal
The easiest way to stop fretting about taking home office business deductions is to take legal deductions.
It’s pretty simple.
If you don’t do anything wrong, even if you get audited, nothing will come of it. But you have to make sure you aren’t doing anything wrong first!
The easiest way to avoid all of this hassle is to pay a Certified Public Accountant to do your taxes.
It will cost you a few hundred dollars more than using boxed tax software, but you’ll know your tax return was legal and accurate. (Plus if something happens, in most cases, it is up to the CPA to then defend the return and not the taxpayer who just signed on the dotted line.)
If you weren’t needing to take a home office deduction boxed tax software is usually a fine choice, but once you start mixing in business expenses getting professional help is a wise move.
Make Sure You Document Your Deductions
Once you decide to use your legal ability to deduct some business expenses for the use of your home, document them.
Again this sounds simple, but having 100% accurate documentation will protect you.
What does this look like?
If you claim you used 120 square feet of a 2400 square foot home for business purposes only, that is 5% of the home. You can then deduct 5% of the associated home costs like your mortgage and utilities. Have all 12 months of your mortgage and utility bills available. Do accurate calculations and make copies of the bills. (And store them in a safe place for the length of time that the IRS could open up an audit on your return.)
No Guarantee of Avoiding an Audit
Unfortunately, even if you do everything by the book you can end up being audited by the IRS. Of course, the audit may not have been triggered by your home office deductions either. There is no way to tell what caused the audit.
However, as much of a hassle an audit it as long as you have taken legal deductions and documented them properly you shouldn’t have much to worry about. (This is also where a CPA comes in handy. “Here Mr. CPA, please take care of this IRS request for me.” Then go back to making income from your home while the CPA deals with the IRS.)
Taking all of this into consideration, even if you do everything by the book, is it worth the potential hassle of an IRS audit to take the deduction?
It really depends on how much of a benefit you are going to get from taking the deduction. If you end up being able to deduct $400 from your taxes you will only lower the amount of tax paid by $100 if you are in the 25% tax bracket. If you run a substantial portion of your business from home and use a lot of the square footage of the property, you might be able to deduct thousands of dollars which would cut your tax owed down substantially.
It all depends on your situation, your business, and how much you could end up deducting from your taxes at the end of the year.
If you have the legal right to cut your tax bill down, why wouldn’t you?
Shawn Hessinger says
Thanks for sharing this and, Kevin, the points you make here are very important to remember, not just for home office but for any business deductions. When it comes to writing anything off on your taxes, be sure to obey the tax code. Don’t be afraid to take what you are entitled to, but check with a professional and experienced tax preparer to be sure you stay out of trouble.
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Actually, don’t be so quick to assume CPAs will always follow the letter of the law. Just like any set of people, their ethics — or, depending on how you look at it, “comfort level” — in what’s deductible varies greatly.
I knew a guy who lived in a studio apartment and his CPA still told him to go ahead and deduct office space. Not even remotely something he could back up.
In the end, it’s highly unlikely that something like a home business expense will actually trigger an audit. At least, if it’s anything like most home business expenses, which are pretty small in the IRS’s eyes. Of course, if you DO get audited, you want to be sure you can back that deduction up.
Interesting note: I studied accounting for a time, and my taxes teacher said that he knew at least one person who worked for the IRS. She told him that if your charitable contributions are less than $500, they skip right over it. I wouldn’t then suggest bloating your charitable contributions up to $499. (Again, if you’re audited, you want to be able to back it up.) Still, if your CPA seems happy to pad those a bit… You’ll know why.
Pete Price says
I just came across this brilliant CPA, Lou Patten in Lake Worth, Florida. After searching for help with my taxes for years, I’ve finally found exactly what I needed. He’s affordable and handled my taxes personally. I highly recommend him. Here’s his website http://www.loupattencpa.com
Lauren @ L Bee and the Money Tree says
So clear! So easy to understand! I love it-and it’s never too early to start thinking about taxes. I think I’m going to have to hire a professional this year since I have so many personal and business costs, it sucks-but I want to make sure it’s done correctly!
Derek Knight says
I have never been auditted, but my taxes are reviewed every year. They send me a letter stating that they have reviewed my taxes and changed the amounts. Sometimes they send me a note stating I overpaid by some measly sum of $1.47, but sometimes they tell me that they changed my taxes owing. When this happens it is an unfair pain in the butt. They fined me and then made me pay the fine + amount of tax owing + interest from the date filed ( Which was almost six months prior ). The fine was 10 times larger than the taxes owing, and the interest was almost as much also.!
Ryan @ Chandler CPA says
Keep in mind with the home office deduction that there are many rules that come into play. It was mentioned above in the post that the home office does have to be exclusive. Additionally depending on the way your business is set up you may not be able to claim it all and may need to actually take a reimbursement. This typically applies to people who are set up as S corporations but keep in mind you should speak with a tax professional.
IRS Circular 230 Disclosure: To ensure compliance with requirements imposed by the IRS, we inform you that any U.S. Federal tax advice contained in this communication (including any attachments) is not intended or written to be used, and cannot be used, for the purpose of (i) avoiding penalties under the Internal Revenue Code or (ii) promoting, marketing or recommending to another party any transaction or matter addressed herein