The regular method
Someone with a larger home office and higher expenses might benefit from sticking with the regular method of determining the home office deduction. You determine the deduction by figuring out the percentage of your home that you use for business.
Claiming your home office deduction using the regular method doesn’t stop at the home itself. You can use your business use calculation to determine how much of the following can be deducted for business use as well:
- Mortgage (or rent) payment
- Utility costs
- Homeowners (or renters) insurance premiums
For example, if your home is 2,500 square feet and your home office is 400 square feet, you use 16% of your home for business. You are allowed to add up 16% of your housing payments, mortgage interest, utility costs, and insurance premiums to use as your home office deduction. For the right person, this can result in a larger tax deduction than the simplified method.
You may be able to divide up your home-related deductions between Schedule A and a business Schedule C or Schedule F , whichever you use. It’s also possible to deduct a portion of the home’s depreciation when you use the regular method.
When you take depreciation, you opt to have the cost of your home office structure spread out over a set period of years, rather than receive the full deduction amount all at once. This can be beneficial if you’re worried about writing off a large purchase all at once and lowering your net income drastically, as the depreciated amount will be far smaller and spread out over a period of years.
Although if your home has appreciated by the time you sell, some of the deduction will be recaptured, meaning the IRS will view the gain as ordinary income. That means you could have to pay capital gains taxes on that appreciation gain.
If your deduction amount is larger than your gross income from the business use of your home, it’s possible to carry the excess amount to the next year. So if your deduction comes to $3,500, but your gross income from the use of your home amounts to $3,000, you can’t claim that “extra” $500, but you can carry it over to the next year. This is a feature that isn’t possible with the simplified method.
Depending on your situation, using the regular method can result in a larger tax deduction. But it also requires more attentive record keeping and calculations. If you plan on using this method or know you have a larger home with more potential for a home office deduction, keep a mental note of your utility costs, interest payments, and any changes in your insurance premiums.
Hold onto all receipts, research additional business deductions to ensure you’re maximizing your return, and be aware of the home office expense deductions: mortgage, interest, utility costs, homeowners (or renters) insurance premiums.