 Income tax 2022-2023. Business use of your home. Let's do some wealth preservation with some tax preparation. Most of this information comes from the Tax Guide for Small Business for Individuals Who Use Schedule C. Publication 334 Tax Year 2022. You can find it on the IRS website, irs.gov, irs.gov. Looking at the income tax formula, we're focused online on income. Remember, in the first half of the income tax formula is in essence an income statement, although just to outline other forms and schedules flowing into these line items, one of those, the Schedule C. Having business income minus business expenses, the net business income from the Schedule C flowing into line one, income of our income tax formula. When we look at the Form 1040, we remember that the Schedule C flows into the Schedule 1, which flows into page 1, Form 1040, line number 8. The Schedule C is the profit or loss from business. It is an income statement format with income minus expenses. We're focused on the expenses here, in particular those related to your home because you're using your home partially for business. So just a quick kind of overview of this type of situation where you live. Support Accounting Instruction by clicking the link below, giving you a free month membership to all of the content on our website, broken out by category, further broken out by course. Each course then organized in a logical, reasonable fashion, making it much more easy to find what you need than can be done on a YouTube page. We also include added resources such as Excel practice problems, PDF files, and more like QuickBooks backup files when applicable. So once again, click the link below for a free month membership to our website and all the content on it. Typically that's your home. You might either be purchasing your home or you might be renting your home. If you have purchased the home, then part of the cost of the home is going to be, you might have a home office, whether or not you rent the home or purchase the home. Remembering that the general concept of being able to deduct something for business purposes, which is the general concept for being able to deduct something for just income tax purposes in general should be that you have to consume it in order to generate revenue. So for the business expenses, they were ordinary and necessary expenses that you had to consume in order to generate the revenue so that we're taxed on net income, not on the gross income. The problem being that sometimes we have expenses that have both a personal and business nature. We need to somehow allocate and break out the business component, which possibly could be deductible versus the personal component. Now if you own the home, you might have an office within the home. How are you going to break out the costs related to the office, which are being paid for as one lump sum for the entire home. So some of those things might include like the utility bill, the water bill, that kind of stuff. You're paying one bill for the entire home. You're not paying a separate bill for your home office. So you're going to have to do some allocation method possibly in order to see what amount might be deductible. When you own the home, then you might have the depreciation on the actual home itself because we've talked about before that if you had an office building, for example, separate for your home, you would depreciate the office building if you had purchased the office building. If your home is, if it's your home being used as a home, then you don't depreciate it because it's not being expensed in that way, right? You're not getting a tax benefit other than the mortgage interest possibly and the property tax is possibly deductible on the schedule A. But if you use it for business purposes, you would think that the deterioration of the home, the depreciation on the home, the part that's related to the office, you might be able to get a benefit from that. That one gets a little bit more confusing. And then you also have possibly the interest on the loan for financing the home, which is already deductible on the schedule A if you're itemizing. But now you might be able to allocate between schedule C and schedule A. You can't typically double dip. You can't deduct the mortgage interest in two places. But for the same mortgage interest, but you might be able to allocate between where it should be deducted, same for the property taxes. Now, if you're a, a renter, then you have the same situation for the utility bill. You have the same situation for that kind of stuff, but you, you rent now. So if you rent, then you're going to have to allocate the rent in a similar way you would with the utility bill and that kind of stuff. And you don't have that depreciation stuff you got to deal with or the home mortgage interest or the property taxes, just basically the rent. It's actually a little bit easier conceptually to deal with the renting situations. Well, how are you going to allocate it? So the logical idea would be there's going to be some kind of ratio analysis. One way you could think about it. What if I take the square footage of my office building and compare that to the square footage of the entire building itself and I get a ratio and then I use that to try to allocate out my costs in proportion to the business versus professional. There might be a simplified method that the IRS will use as well that you can use a simplified method. You might want to use the one that comes to the, to the most benefit. And then the question is, well, what qualifies for business use property? If I do, if I just do some, some business work in my bed or something like that, can I write off the square footage of my bed compared to the most likely not because your bed, although you might do some work that's business related in it is probably personal use as well. And therefore not subject to, to an expense for business related. It's got to be something exclusively for business, typically. Okay, that's the general idea. Let's dive in. So business use of your home to deduct expenses related to the part of your home use for business. You must meet specific requirements. Even then, your deduction may be limited to qualify to claim expenses for business use of your home. You must meet the following tests. Number one test, your use of the business part of your home must be a exclusive. However, see exceptions to exclusive use later. So generally, the business use of your place, the business place that you're using needs to be exclusive business, although exceptions could apply because when you talk about all these different kinds of businesses, there can be weird situations. A daycare situation is one that comes to mind that could be a particular exception because you're using daycare facilities with kids running around in areas where they might be personal at other times and inventory can sometimes cause problems as well. Okay, be regular and see for for your business. Okay, number two, the business part of your home must be a your principal place of business defined later. So meaning, you know, if I can deduct it is that my principal place of business, you're usually kind of thinking like office space. In that case, is that where I do like my executive work or I meet my patients there or something like that as opposed to like a secondary office like yeah, check my emails at that place every once in a while. That's not really your principal place of business. If you do your executive work and you're visiting the patients outside of that area, for example, you would think so be a place where you meet or deal with patients, clients or customers in the normal course of business. So if you're dealing with clients in the service, if you're if you're dealing with advice or you're a doctor or you're doing some kind of service or like a professional services or whatnot, is that is that happening, you know, in the in the home, you would think that would be where you're doing a lot of the work then see a separate structure not attached to your home. You use in connection with your home. So the business part of your home must be so a separate structure not attached to your home use in connection with your home. So notice there's an or there, not an not an and so it's got to be a be or see if it's a separate structure. Okay, exclusive use to qualify under the exclusive use test. You must use a specific area of your home only for your trade or business. So you're using whatever area of your home. It's your actual home, not necessarily a separate structure or anything like that. But the part of your home that you're using is exclusive use, right? The area used for business can be room room or other separately identifiable space. Now this is where it gets tricky, because if you dedicate an entire room just to business, that's pretty straightforward. That room is my business room. That's where I do business when I do personal stuff. I'm not in that room or whatever. But if you if you have like an open home, where you know, you're going to designate a part of your open home that's not as you don't have all that you get a modern house that doesn't have any rooms man, it's all open with open windows everywhere. Well, then you got to designate some space in some way. And the question would be, is that legitimate enough to designate that space for, you know, business use. So the space does not need to be marked off by a permanent partition. So that's nice, meaning doesn't have to have like, I've walled this thing off with a wall here, a permanent partition. So you do, you, you do not meet the requirements of exclusive use test if you use the area in question, both for business and for personal purposes. So example, you are an attorney and use a den in your home to write legal briefs and prepare clients tax returns. Your family also uses the den for recreation. The den is not used exclusively in your profession. So you cannot claim a business deduction for its use. So you've got a den. So but it sounds like it's being used like as a living room, because people are using it for their personal use as opposed to you just using it for your business. Therefore, you would think it wouldn't apply it or be applicable in that case, exceptions to the exclusive rule. So there are there any exceptions here? So you do not have to meet the exclusive use tests to the extent you use part of your home and either of the following ways. Number one, for the storage of inventory or product samples. So inventory kind of muddies up things a little bit because now you're doing it for inventory, which is a bit different use than than like an office to as a daycare facility. So that's a one of those items where oftentimes you're going to have to daycare kids are running around in areas that would be personal use other than the daycare because the whole point of the daycare is to have a like a personal family use type facility for daycare things. So for an explanation of these exceptions see publication 587. So if you want to dive into those in more detail, you can check out that publication of the iris.gov iris.gov business use of your home publication 587. So regular use to qualify under the regular use test, you must use a specific area of your home for business on a continuing basis. You do not meet the test if your business use of the area is only occasional or incidental. So if you're like, Yeah, I got this extra room in my home. And it's like a home office. I don't use it because I got like a big home and whatnot. But every once in a while I go in there like twice a year and do and you know, jump on my business emails. Well, that doesn't sound like regular. That doesn't sound like regular use of the of the area. So so even if you do do not use that area for any other purpose. So you might say I don't use it for any other purpose because I've I've got my big house. I never even go into that room. But I just use it two times. It doesn't sound like regular use. Okay, so principle place of business. You can have more than one business location, including your home for a single trader business to qualify to deduct the expenses for the business use of your home under the principle place of business test. So now it's got to be the principle place your home must be your principle place of business for that business. So what does that mean? How do I get to that determination? So determine your principle place of business, you must consider all the facts and circumstances, just like a detective. So your home office will qualify as your principle place of business for deducting expenses for its use if you meet the following requirements, you use exclusively and regularly for administration or management activities of your business. So in other words, you might be in the type of business where you're you're going elsewhere and you're you're visiting clients and that kind of stuff. And that some businesses, that's going to be the main revenue generation part of the business. But you're doing your administration work kind of managing your business. And that's kind of thought of as your central hub then of the managing of of the business in the home office. So that might be a qualification for the principle place of business, which is what you want for your home office. So you can deduct the home office portion of the home. You have no other fixed location where you conduct substantial administration or management activities of your business. So if you're like, yeah, I've got this other office somewhere else. This is like that other similar to that other situation where we were talking about if you just had an office that you just said was your office, but you don't use it that much. Why don't you use it? Well, maybe I got an office somewhere else and I use that office. But then I come into this office twice a year and check my emails in my home. What's not your admit it is not your principal office location, then either you would think it might not qualify for the principal place of business, which is going to be a problem for deducting the home office. So alternatively, if you use your home exclusively and regularly for your business, but your home office does not qualify as your principal place of business based on the previous rules, you determine your principal place of business based on the following factors, the relative importance of the activities performed at each location. So if the relative importance factors does not determine your principal place of business, you can also consider the time spent at each location. So you were trying to default down to, can I qualify something as my principal place of business based on time? If there's like a tie, you know, between. So if after considering your business locations, your home cannot be identified as your principal place of business, you cannot deduct home office expenses. However, for other ways to qualify to deduct home office expenses, you could see publication 587. So you can keep trying there. So deduction limit. So we've got to let, is there any limits to this kind of home office deduction? Indeed, there are some limits. So if your gross income from the business use of your home equals or exceeds your total business expenses, including depreciation, you can deduct all your business expenses related to the use of your home. If your gross income from the business use is less than your total business expenses, your deduction for certain expenses for the business use of your home is limited. Now note what's happening here. You've got, you've got your income statement on the schedule C income minus expenses. And if you get into the lost territory, we know that's a danger zone. You're getting into the danger zone for the IRS to see whether or not they're going to allow the deduction because if they allow you to get this big loss due to big deductions such as the business use of the home, it can be, then you can take that loss against other income like W2 income or something like that. And the IRS is skeptical of losses. They want, they want to be your partner when you're making money, not when you're losing money. You know, so there's, so you got, whenever you get into lost territory, you got to think about, well, there might be some limitations here. What's going to happen in that situation? And what happens here? They might limit the home office deductions based on your business income. So your deduction of otherwise non-deductible expenses such as insurance, utilities and depreciation with depreciation taken last, allocable to the business is limited to the gross income from the business use of your home minus the sum of the following. Number one, the business, Mr. Business, Mr. Business, part of expenses you could deduct even if you did not use your home for business such as the mortgage interest, real estate taxes and casualty and theft losses that are allowable as itemized deductions on schedule A. So, you know, you would think you may, may still be able to get some benefit from those deductions considering the fact that you would have been able to deduct them on a schedule A as, as an itemized deduction. And two, the business expenses that relate to the business activity in the home, for example, business phone, supplies and depreciation on equipment, but not the use of the home itself. So these are, these things look like just normal business expenses, right? So a bit like the business, the business use of your phone, it sounds like a normal business expense, so it shouldn't be limited as opposed to the expenses on the home itself, like depreciation, for example, our supplies sound like normal business expenses. So even though you're using supplies in your home, you would expect the supplies to be deductible because they're normal business expenses as opposed to the, the depreciation, say, on the home itself, if you purchase the home or possibly rent, if you're renting it. So do not include into above your depreciation, appreciation for one half of your SE self-employment tax. Use form 8829 expenses for business use of your home to figure your deduction. So simplified method. So here's the, now the question is, well, how are you going to do this? Well, there's the square footage kind of method that you can use, and then there's the simplified method. Now the simplified method, although simpler, you want to think about which of the two methods will give you the most benefit. So if you're, if you have a simplified method where they're just going to say, hey, take the square footage and we're going to give you so much per square foot, then that might be a good method, but they have to take an average if it's a federal income tax, because they may not be breaking it out between the cost of living differences between states. So you would expect that method to be low for high cost of living states like California and New York, and you would expect it maybe to work well for low cost of living states, because they're going to have to pick some method that is appropriate or across the entire country, unless they're going to try to stratify how much they would give for a simplified method based on where you live and cost of living of where you live. So the IRS provides a simplified method to determine your expenses for business use of your home. The simplified method is an alternative to calculating and substantiating actual expenses. So in most cases, you will figure your deduction by multiplying five dollars, so just five dollars by the area of your home used for qualified business use. So the area you use to figure your deduction is limited to 300 square feet. So five dollars. So again, that might be low if you're in high cost of living areas. So if you want to do it both ways, most likely, and say is the other method going to be higher, and see if you want to take which of the two, and if you have a large space that's greater than 300 square feet, then you probably don't want to use the simplified method either. So for more information, you can see instructions for Schedule C. More information. So for more information on deducting expenses for the business use of your home, see publication 587.