Freelancing isn’t your typical nine to five. With flexible hours, independence, and the ability to work from home, freelancers have numerous perks unoffered in traditional employment. But that doesn’t mean freelancing doesn’t come with its own stressors – meeting deadlines, client networking, and managing finances to name a few. On top of that, freelancers are also responsible for filing their own taxes and may not be aware of all of the qualified tax deductions – especially home office business deductions if you are using part of your home for business (such as a spare bedroom or garage).
The tax season can add extra stress to your already busy schedules and can be an overwhelming process for anyone. Advance preparation and knowing which business and home expenses you can deduct can reduce your taxable income and create a smoother, stress-free process. At Indy, we aim to make freelancing simple, and help you through the tax season. In this article, we’ll take you through the process of verifying whether your home business space qualifies for the deduction, what you can claim, and how to calculate expenses so that you can save big on your taxes and keep more of that hard-earned cash.
Who qualifies for the home office expense deduction?
Available for both renters and homeowners, the home office tax deduction allows self-employed small business owners (sole proprietors, limited liability owners, or partners in a partnership) to claim expenses for the use of a home business space.
In order to take this deduction, you must be able to show you are self-employed and meet one of these criteria, per the IRS’ guidelines:
- Regularly and exclusively use the space as your principal place of business
- Regularly and exclusively use the space to meet clients, customers, or patients in relation to your business
- A separate structure (e.g., a garage used as an office on your property) not attached to your house used regularly and exclusively for your business
- A space used regularly for inventory or product samples (retail business)
- As a day-care service
It is also important to note that effective from 2018 through 2025, employees are no longer eligible to claim home office tax deduction – you must be a self employed individual.
What is "exclusive use"?
“Exclusively” means that the space is only used for business. The space doesn’t have to be physically separate to qualify2 and can be a section of a room, as long as the space is used solely for your business.
What is "regular use"?
“Regularly” means the space is used on a regular basis for business. For example, if you use the space once a month for admin work/paying bills it qualifies. However, if you only use the space once a year for business (such as to complete a tax return), it most likely won’t qualify.
What qualifies as "business use"?
“Business purposes” means your office space must be the principal place of business and used for only conducting business that produces income (selling goods or services). For this reason, non-profits don’t qualify for home office tax deduction.
How do I calculate the home office tax deduction?
There are two ways business owners can calculate their home office deduction: the simplified option or actual expenses.
The simplified option
Instead of maintaining a record of your expenses, this option allows you to deduct $5 based on the square footage of your office space (maximum deduction is up to 300 square feet). To do this calculation, multiply the square footage of your home office by $5.
For example, if your home office is 200 square feet, multiply that by $5 for an eligible deduction of $1000. This method works best for small business owners who operate in a small space, and means certain records (expenses) will not need to be maintained as thoroughly.
The actual expenses method
The actual expense method is used for reducing expenses, such as repairs, and is best for office spaces larger than the 300 square foot limit in the simplified method. In this section, we'll explore how the actual expense method is calculated and what you'll need to do this calculation.
What will I need to do to calculate the actual expense method?
Under IRS' guidelines, in order to calculate actual expenses, you must divide the expenses of operating your home between business and personal use. There are three types of expenses in this method:
- Direct expenses - exclusively for the business part of your home, for example, repairs or painting only in the space used for business. This is deductible in full.
- Indirect expenses - for the upkeep of your entire house, for example, insurance, general repairs, and utilities. This is deductible based on the percentage of your home used for business (more information in next section).
- Unrelated expenses - the parts of your home that are not used for business. For example, painting a room outside of your business space. This is not deductible.
How do I calculate the actual expense method?
If the above information seems a little overwhelming, don't panic. This section provides a simple overview of step-by-step instructions to calculate your expenses.
First, you need to calculate the percentage of your home office space. For this, you have to divide your total home area by your office space. For example, if your total home area is 1,700 square feet and your home office space is 340 square feet, then your home office space is 20% of your home space.
Once you have calculated the percentage of your home office space, you need to divide your home and home business and related expenses into the three types mentioned above.
For the indirect expenses, these are deductible based on your home's square footage that your office space takes up. For the example above, you would qualify for a 20% deduction on indirect expenses.
Let's say you rent your home, you can deduct part of the rent you pay by multiplying your rent payments by the percentage of your home used for business. If you paid $3000 rent, you would be eligible for a $750 deduction ($3000 divided by 20%).
The IRS Publication 587 offers a thorough breakdown of the actual expense method.
Is it worth claiming home office business expenses?
Freelancers working from home can save big on their taxes using the home office deduction. However, there are a few points to consider before claiming.
One downside of claiming a home office is an effect on earnings tax in case of selling the house. People who sell their house after residing in it for at least two of the five years before the sale, often don't have to pay taxes on up to $250,000 in profit on the sale (or $500,000 if married and filing jointly).
This means homeowners who claim the home office deduction under the actual expenses approach may lose the opportunity to defer paying capital gains tax when they sell.
When deciding which method to use for the home office deduction, it's also important to note that by using the actual expenses method, you are required to depreciate the value of your home. Depreciation is an income tax deduction that allows taxpayers to recover the costs of the property (such as wear and tear).
This means, if, for example, you are using 20% of your home as an office space, 20% of your home's sale may be taxed on capital gains. However, if you use the simplified method, depreciation isn't a factor.
How Indy can help
At Indy, we aim to make freelancing simple. There are several ways Indy can help you with taxes:
- Our project tools can help manage your calendar and contracts throughout the year. With our project tools, you can also set up monthly reminders to manage your receipts and invoices so everything will be manageable and ready for the tax season.
- Our online invoice software can take the hassle out of invoicing, with a generator that produces templates in seconds. Our invoice tools also make it easy to send invoices at set intervals - perfect for freelancers with recurring clients.
No matter the industry, Indy can help you save time and manage your admin all on one platform. Sign-up now and try it for yourself!
Conclusion
Whether you use the simplified or actual expenses method, the home office deduction can significantly reduce your taxable income. As long as your office space meets the IRS requirements (regularly and exclusively use the space as your principal place of business), by taking the reduction, you may be eligible for a tax deduction of $1500.
The home office deduction is just one of many eligible tax deductions for freelancers. You can check out our guide on bank fees and interest deductions for freelancers for some more eligible deductions and tax saving tips.
Frequently Asked Questions (FAQs)
How do I take the home office deduction?
If you have chosen the simplified deduction, you can deduct your company expenditures and revenue immediately on Schedule C. For the actual expenses method, you must include Form 8829 with your income tax return.
If the expenses from your home office exceed your annual business income, your home office deduction may be restricted.
What if I was in self employment for only a few months?
If you were self employed for only a few months - perhaps you did some freelance work whilst seeking full-time employment - you may still be eligible for partial home office business deduction.
In this circumstance, IRS guidelines state that you will only be eligible for the expenses for the months you were self employed. Using the same process as above, you must only calculate expenses for the months you were working.
Let's say you worked from your home office as a freelance writer from July to December last tax year. During this time you spent $1700 on rent and your home office equates to 25% of your home space. Using the actual expense method, you would be eligible for a $272 deduction ($1700 divided by 25%) for the six-months you worked from your home office.
What other home office expenses can I claim?
As a self employed freelancer, you may be eligible to deduct other expenses for setting up a home office. This includes equipment and furniture. For example, a computer, printer, office desk and chair are just a few examples of eligible home office tax deductions - as long as they are used for business purposes. A dedicated phone line is another example of an eligible home office business expense.
For more information about eligible home office deductions, see IRS Publication 535 Business Expenses.
What if my business has just one home office, but most of my work is completed elsewhere?
In order to be eligible for the home office deduction, your home office space should be your principal place of business, not your principal workplace. This means, as long as you are using your home office to conduct your business (e.g. administrative or management activities, selling goods) and you are not substantially using any other fixed location to conduct these activities, you are eligible.
This means, even if you conduct most of your income-earning business activities from elsewhere (for example meeting clients), you are still eligible as long as your home office space is your principal place of business.
If you are an employee of another company, but also work part-time as a self employed freelancer from home, you are still eligible for the home office deduction even if you spend more time as an employee.
