 Income tax 2022-2023, business use of your home tax software example, let's do some wealth preservation with some tax preparation. We are in our example Form 1040 populated with LISERT tax software. You don't need tax software to follow along, but it's a great tool to run scenarios with. You can also get access to the Form 1040 related forms and schedules at the IRS, iris.gov, iris.gov, starting point single filer Mr. Anderson living in Beverly Hills 90210. 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. No W2 income because we've got the business income coming in from the schedule. Let's see that flow through process going to the schedule see profit or loss from business income statement format income minus expenses the net income in essence going into the schedule one going from the schedule one to the form 1040 line number eight. We're going to have to pay self-employment tax on that income. Let's see how that works. It goes from the schedule see bottom line net income flowing into the schedule se self-employment tax calculating that at 14129 that social security and Medicare we're going to go into the schedule to that's right there flows in 14129 flows into the form 1040 page number two not the income tax but other taxes down here 14129 the self-employment tax half of that's deductible on page one of the form 1040 right there we could see that flow through by going to the schedule see net income being used to calculate the self-employment tax of that 14129 half of it 7065 flowing into schedule a number one page number two right there and that flows into the form 1040 right here. So now we've got the 100,000 minus the 7065 gives us the 92935 minus the 12,950 standard deduction and the 15998 which is the qualified business income calculated by the software at this time gives us the 63988 taxable income tax calculated on page number two 9,692 for the income tax and the 14129 for the self-employment tax gets us to the 23821 total tax we're imagining we paid 30,000 for a difference of 6179 our focus now on the schedule see imagining we now have the business use of the home so the general scenario is we've got our own sole proprietor type of business we have our home which we might be renting or we might be purchased we might have purchased the home in either case we use part of the home for business use so we can imagine we have an office in some way shape or form some designated space that we're using within the home now you would think that we would get to deduct part of the costs that are applicable to the business use of the home considering the fact that it's you had to consume that business use in order to generate revenue the problem that many of the expenses that you have are going to be for the entire home so they're personal and business therefore we need to be breaking out the business versus personal portion how could you do that well we could do that possibly with ratio kind of scenario meaning we can take the square footage of the business use and divide that by the square footage of the total home and get a ratio a percent in essence that we can then allocate these costs by we can use the form 8 8 to 9 which we will take a look at let's open that up we can also use by the way a simplified method which may be okay to use but may be low as well depending on where you live if you live in like a high cost of living area you're likely not going to want to use the simplified method because your your cost of living is going to be higher and so that might be short also note that the deduction is flowing down here and that's kind of an indication that and the reason they might do that or put it down here as opposed to up top is because there could be limitations in terms of how much you can deduct in the event that you have a loss situation so if you have a loss remember that if you have a loss here that could pull to page one of the 1040 and be deductible against other incomes such as W2 income if you had any and that could cause you know issues the iris is skeptical of that so you might have limitations with regards to the losses okay so let's go ahead and and open up the form 8829 so I'm going to open that one up let's find that over here so here's the basic layout we've got the form 8829 business expenses for business use of the home part one part of your home used for business and then figure your allowable deduction notice the two categories we have here the direct expenses and the indirect expenses for the business use of the home let's jump on over let's see if I can do a jumping format here and go to the business use of the home okay so so if we're going to use the percentage square footage method what we would basically need to do is say okay the business use of the home I'll pull up my trusty ruler and map out the square footage of the business area and let's say that that comes out to uh let's say that comes out to 700 let's say let's say 300 and the total area of the home which you might be able to find when you purchase the home the square footage you might be able to look it up online and see what the like the square footage of of the home is but you have to find the square footage of the home if you're renting obviously you can you could you could look at the rental agreement possibly to find the square footage of the home or look up online for the standard unit size of the home and whatnot so we've got our two major categories the indirect expenses and the direct expenses so the general idea would be if it's an indirect expense we're paying for something like the utility bill for example on the entire home and part of it should be allocated to the business use and that's when we're going to have to use that percentage kind of method to do that if it's a direct expense that might be something that we're paying for directly to the office so for example if we're paying like repairs and maintenance for like the entire roof of the building then you would think that you would have to use a indirect method and you would have to allocate it between the business and personal but if you're doing repairs and maintenance for the actual office itself then then you don't have to do the allocation method because you're repairing the actual office which is full business use and in that case so that's the general idea note that up top we've got the mortgage interest and the real estate taxes now and this and the state mortgage interest now these are going to be deductions if you have the purchase of the home and they also become more confusing because you may be able to deduct these items on the schedule a if you're taking the itemized deduction so then you got to think about whether or not they should be allocated between itemized deductions and the business deductions if you're not taking them on the schedule a then you would think that you might get a benefit from them on the business side because you're not taking them on the schedule a because possibly you have standard deductions that you're taking as opposed to itemized but if someone owns a home usually that's one of the big items that pushes people over from the standard deduction to taking the itemized deduction and then you run into that issue also mortgage interest from an itemized deduction schedule a standpoint is could be limited if the loan is over a certain threshold which could further complicate things usually would only happen on more wealthy individuals same with state taxes for example which are capped on the itemized deductions I think at like 10 000 so then again that kind of complicates things as well with the state taxes but let's first think about the the renting situation because I think that's a little bit easier easier so you've got insurance miscellaneous the rent let's say we're paying rent and let's say that that's going to be let's just pick a number of 20 000 in rent now the the repairs and maintenance this would be if the repairs and maintenance were on the entire home like the roof of the entire home and I need to allocate them between the two so let's say that's 1200 utilities let's say that's 700 on the whole home and excess mortgage interest state excess more excess real estate taxes and other items and then on the direct items mortgage interest real estate taxes if they were directly applied to the office which would be a little bit more unusual you know on those two items casualty losses insurance for the office itself miscellaneous rent for just the office that would be a little bit unusual repairs and maintenance it's likely that you might be able to do repairs and maintenance just on the office maybe so maybe I fixed something in the office for like 300 I don't have to allocate that between personal and business because I repaired my home but it was to the office itself utilities if you were able to somehow figure the utilities or break them out to have it just for the office portion without using the indirect method but usually you would have to use the indirect method excess mortgage excess real estate taxes casualty losses so let's keep it at that and let's start there let's see what we get so then I'm going to pull this on over and let's just check out what it populated here for the form so part one part of your home used for business so we've got the 300 area used regularly and exclusively for business and then the total area of the home we're saying was the 1200 if I pull out the trustee calculator there's the trustee calculators to come to save the day 300 divided by 12,000 is a 0.25 percent right so then we're going to say all right that's going to be our ratio it's a little low on the ratio but we'll say that's going to be it so then we've got the 2.5 percent and then the amount of the schedule see so it's going to pull this over from the schedule see because it's trying to see if there's going to be a limitation and then up top we've got the casualty losses deductible mortgage interest and the real estate taxes but we're focused down here on these items we have the direct expenses and the indirect expenses so for the direct expenses the ones that we can apply directly to the office itself we put that 300 dollars in for the repairs and maintenance that we imagined on the office the rent however indirect same with the repairs and maintenance for the whole for the roof of the home we imagined and the utilities for the whole home that comes up to the 21 900 and so then we have multiply 23 column b by line by line 7 which is our percent which would make sense so the indirect items are the 21 900 times the 0.025 that gives us our 5 48 about so that 5 48 is the portion of the indirect items and then we're gonna we're gonna add that plus the 300 the 300 and because that's the direct that we get and that comes about to 8 48 that flows into the schedule see notice it's not in the normal kind of deductions up top but rather down below down here and that's going to be then populate into the 9 9 1 5 152 which ultimately of course pulls over to the form 10 40 here so that's the general idea of it now if you own the home it becomes a little bit more complex because then you've got the mortgage interest and possibly depreciation that you have to deal with so just to give you an idea of why that's a little bit more complex it's because I'm not going to have the rent here the rest might be somewhat the same but then I've got like the mortgage interest so let's say the mortgage interest was I'm going to pick a high you know fairly 20 000 to try to also think about what would happen on the schedule a and then I'm going to say that the real estate taxes let's say we're 7 000 so now when I pull that over notice what's happened here I'm on the form 8 8 2 9 and I've got that populated up top here so now it's in this area where I've got the 20 000 and the 7 000 adding to the 27 000 but then I have this little worksheet which is telling me the allocation between the schedule a and the form 8 8 2 9 why did that come into play remember before when I went to the form 10 40 we were taking the standard deduction as opposed to the itemized deductions the things that usually kick people over to take in the itemized deduction is owned in a home because you're possibly most likely have a loan on that and the mortgage interest could be deductible as an itemized deductions as well as the property taxes so if I go to the schedule a now what it did is it basically populated now into this area for the taxes that were paid and so now we've got the the state local real estate taxes are being allocated here it's using an allocation method to do to allocate here and then we've got the interest which is being allocated here now that gets quite confusing when you do the data input because if you were to try to look at this and say well where did this data input come from you would be jumping to the the schedule a you'd be going all right where's my itemized deductions and I would be going into the schedule a and say where's my interest over here and there's nothing in the data input field for the interest why because we put we put it over here in the form eight eight two nine so it can properly allocate the interest to the schedule a and the and the home business use in accordance with the ratio so that gets messy also note that again if you did hit the limits for the amount of mortgage interest that you can deduct because of the loan thresholds that could complicate things although that's a little bit unusual but what's more common is that if your income goes above the $10,000 threshold which is typically deductible on the taxes over here for the state taxes that can complicate things a little bit as well but in any case you get the idea that you would think that you would have to basically allocate between the schedule a and the form eight eight two nine if you're taking a schedule a deduction if you're not taking the schedule a deduction then maybe that's not as applicable because you're not going to be you're not going to be itemizing so if you're still under and taking the standard deduction then you'd be in a similar kind of situation as the rent okay so then you know that so in that case we see that that is calculation that calculation is up top taking place here instead of instead of basically down here but everything else is somewhat similar the allocation as you can see is if I took the 20,000 of interest for example 20,000 of interest times the 0.025 that's where we're getting the 500 that's being allocated to the to the eight eight two nine and then the 20,000 of interest minus that 500 the 500 is where the rest is getting allocated to the schedule a the 19 500 which we just saw on the schedule a similar kind of thing for the property taxes we would expect all right so the other thing that gets confusing if you own the home is that what you don't get on the schedule a remember that the schedule a by the way is weird for these taxes so the taxes and the interest why do I get to deduct this interest it's on a personal thing if I wasn't using it for business that's weird thing to have so it kind of muddies our thinking of what deductions kind of normally are but usually you wouldn't get a deduction for the home because the home is for personal use so but so if but if we bought the home as an office if we bought an office building in other words we would be able to depreciate the cost of the office building so I would so then you would think well I would should be able to depreciate the portion of my home that I'm using as an office so that's a that's the other thing that kind of muddies things up now the other thing that kind of muddies things up with depreciation is that it'll also possibly adjust your your cost or basis in the home so when you sell the home it'll it'll make that could make that more complicated because it could lower your basis resulting in a higher gain and and that gets another thing that could get a little confusing but let's put the home on the books and depreciate it okay so if you're putting the depreciable home on the books you've got to be careful in terms of what's going to be the cost of the home because it you might have your business that started after so now you got to think about what the basis basically of the home is and that kind of stuff and make sure that you've got the method of depreciation correct and that kind of thing but let's just get the general concept here because the general idea would be that we put the depreciation on the books now we have a depreciation schedule it's the basis I said was 300,000 and the home 2.5 business in accordance with the ratio that we used so that means the the depreciation is a basis is going to be 7,500 and then it's using the straight line mid-month 27.5 I'm going to get to the 261 which now pulls into our expenses for business use and so now that's going to be added here at the 261 so that also gets quite a lot more complicated than just kind of allocating the rent over and like I say it gets a little bit complicated to figure the basis of the home and the out and then to and then to think about what that's going to have on an effect on your basis in the home if you sell the home and that kind of stuff at a future point but that's the general idea okay so now let's go back to the renting situation because it's an easier situation I think and then think about what if we had a loss and then the simplified method so I've changed it now so we're back to like renting instead of owning the home no depreciation we just got the the rent here in our calculation coming out to the 848 that's pulling over to the schedule C on down below so let's say that we had a loss on the schedule C so I'm going to go to the schedule C and say okay let's say that the schedule C is like a break even almost break even but with it before the business home so 120 000 so so now I've got 120 minus the 120 and nothing's happening with regards to the the business use of the home because it's basically restricted it and you can see that over here on the form 8 8 2 6 same form is being populated and calculated but it restricted it and down here on part four carryover of unallowed expenses to 2023 next year operating expenses subtract line 27 from 26 if left since zero so there it is pulling over let's say we had just a little bit of income let's say the income let's add like let's let's let's remove like 200 here and just to nail this point home and go to the schedule C so now you've got this was the income before the home use of the office and now it's allowing you know the 200 here and that's bringing us back down to zero the general idea so you could see what is happening conceptually so now it's limited by the 200 and now the carryover is the 648 all right now this time I forced it to use the simplified method and you can see it comes out to be far worse using the simplified method so if I scroll down I said I just used the simplified method so now we've got the simplified method enter the total square footage of your home we said was the 12,000 and be the part of your home for business use is the 300 used a simplified method and so on which I believe is just taking that 300 times the five dollars and then multiple times well hold on it's being limited let me go back on over here and say let's bring our income back up so we can get a fair comparison here that's not fair that's not fair the way you did it 20,000 okay and then so now we've got our income back on the board okay so there we go so now now the simplified method is the 300 times five right so 300 times the five dollars the 1500 it's not being limited the 300 just being the square footage in essence of the office now this is actually coming out to be higher because we put a we put a square footage of our business use compared to the full the ratio was quite small that we used so you can see you'd want to do both of these methods because because note that you would think that this method because it's for the whole country might work out better if you were in a situation where you were where you're in a lower cost of living place and you have to be under the 300 square foot because if it was over 300 I think it's going to cap it at 300 so for example if I put this at 500 for my business use then it still caps it at 300 right so that's going to be a limitation as well and because there's different cost of livings within the country you would think that it would be likely that if you live in a high cost of living area it might be better to use the actual so now that I've changed this to 500 it limited to 300 let's go back to the other method I'm coming up to 1500 here and if I use the other method it would we would be coming to 1213 so let's just increase that a little bit more let's say it was you know 600 600 and so now we're at the 1395 go back on over and let's say the rent was higher let's say the rent was 35 000 so now we come to 2145 right so so and then if I go back on over and I say okay let's force the other method which is where's the forcer thing where's the forcer thing this method then that would still be capping me at the 1500 so you kind of have to do they try to do the simplified method as if you can just pick the simplified method and go but that actually makes it so you have to do the comparison between the two methods to try to figure out which method is the best now so that's the general idea you can dive into this in a lot more detail to determine you know how to exactly calculate the square foot and special situations like inventory or if you have a separate structure that you that you need to get into you can do more research on that or if you have a daycare facility in particular it goes into a lot more special circumstances in that particular situation or industry which is quite common you know business use a type of business for the business use of the home so you can dive into those in more detail and research them on the iris website iris.gov