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10 Facts You Should Know about Your Home Based Business and Taxes

Deductions, Calculating the Space

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Home based businesses have special tax situations. Home businesses are may take deductions for business use of the home and for direct and indirect business expenses for home maintenance and repairs. But home based businesses are also more likely to be subject to tax audit, because it is easy to over-deduct home business expenses, either intentionally or unintentionally. Before you take any home business deductions, be sure to talk with your tax advisor. Before you talk to your tax advisor, here are some facts you should know about home business taxes:

  1. The IRS requires that the home office be used "exclusively and regularly" for business purposes. Regularly can mean anything from all day, every day to once a month. The IRS says, "Incidental or occasional business use is not regular use." If you use the space for day care, rental, or storage, you must use the space regularly but you don't have to use it exclusively to get the deduction.

  2. The office must be the principal place of business, a place where the owner meets with patients, clients, or customers in the normal course of business, or a separate structure not attached to the home and which is used in connection with the business. Even if the personal use is only once a year, it does not meet the "exclusive" test.

  3. Some parts of your home business deduction may be limited if your home business has a loss or if the profit from your business is less than the deduction you want to claim. Read more about limits to home based business deductions.

  4. The amount deductible for home office space depends on the percentage of the home used for business. You must first calculate the percentage of space, then apply it to expenses. Read more about how to calculate the percentage of home business space.

  5. You can deduct both direct and indirect expenses, but in different percentages. You can take 100% of direct expenses - those directly related to your business. For example, if you paint your home office or put carpeting in the office, you can deduct those direct costs. But you can take only a percentage of indirect costs - those home expenses which can be applied to the business according to the percentage you determined. For example, you can deduct the home office percentage of mortgage interest, property taxes, homeowner's insurance, and utilities. For example, if your home office is 5% of your home's overall floor space, you can deduct 5% of these indirect costs.

  6. You can deduct home improvements only if they are directly related to the business area of the home. For example, you can't deduct the cost of a new patio on the other side of the house, but you can deduct the cost of new siding for the whole house (the percentage related to the business, of course). Read more about home business tax myths.

  7. You can deduct business mileagefrom your home based business to work sites or customer homes or offices, or to other locations for your business or for business errands, but you can't deduct personal errands. Be sure to keep excellent records showing business miles and the purpose for each business-related trip.

  8. To calculate the amount of your home business deduction, use IRS Form 8829 and include this deduction amount on line 30 of your Schedule C or other income tax form, if you are filing your business taxes through your personal tax return (for sole proprietors and single-member LLCs). Form 8829 walks you through the process of calculating the percentage of your home's space that is used for your home business, then applying that percentage to indirect expenses, and adding direct expenses and other expenses, to determine the total home business deduction.

  9. If you sell your home which includes your home-based business, you can usually exclude the profit from the sale from your business taxes. But you must meet specific criteria for this exclusion. including the requirement that the business area must be part of the home (not a separate building). Read more about about taxes on sale of home with home based business

  10. The IRS has the right to come to your home at any time to audit your home business to see if you are following IRS regulations about the "regular and exclusive" use of this section of your home for business use and complying with other home business regulations. Don't over-estimate the space and be sure your space can hold up to IRS scrutiny. Read more about how to prepare for an IRS audit of your home business.
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