Are You A Home Business Owner? Here are Common Tax Deductions You Need To Know

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April 28, 2022
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Common Tax Deductions

Since the pandemic hit, a number of people have started to run home-based businesses. Small business owners, as well as entrepreneurs, have opted to take advantage of the big savings they could gain from taking the home office deduction. It comes with a condition, though – IRS requirements must be fulfilled and businesses must maintain good records. 

It is no secret that home-based businesses have taken a blow of extra costs over the years and legislators are not turning a blind eye to this situation. As such, numerous lines into the tax code have been submitted by legislators in order to help these businesses to come to terms with their taxes as they business at home. 

During tax season, it is of great importance that home-based businesses or entrepreneurs are aware of the important information they when filing their tax returns, particularly, which qualifying expenses are allowed for business use of their homes. Listed below are the most common home office deductions to learn about.

Cost of Goods Sold

Cost of goods sold (COGS) is generally the total amount your business paid as a cost directly related to the sale of products. The cost of the materials and labor directly used to create the good is also included in the computation. Although indirect costs, such as distribution and marketing costs are excluded. 

Understand that the COGS is an important part of your business tax return since it ​​is the absolute lowest price you can sell a product to break even. Considering that there are costs that are general to your business, which is typically not dedicated to a specific item or product, it would fall under overhead, not the cost of goods sold. Cost of goods sold include:

  • Labor
  • Rent
  • Equipment
  • Electricity to run the operations
  • Marketing

Now, Keeping track of COGS as well as other line items is imperative particularly, if you want to keep a good record for the Internal Revenue Services (IRS). Calculating all business expenses, including COGS, will allow home-based businesses to pay taxes on net income only. Meaning, that the total amount of taxes owed when it comes time to pay taxes will decrease.

Capital Expenses for a Small Business

Capital expenditure is any amount of money spent to create a long-term benefit. In other words, they are expenses for capital assets. Home-based businesses invest money in several types of assets (things of value) which may vary from a building, computer equipment, or office furniture. It could also be the improvement of these assets. Take note that capital expenses appear in your balance sheet and cash flow statement.

Now, as a homeowner running a small business and looking for tax cuts, you are allowed to have more generous depreciation benefits to businesses to buy capital assets under the Tax Cuts and Jobs Act (2017). Deductions for capital expenses typically must occur over several years, except where Section 179 applies. 

Over time, you may be able to recover the amount you spend by spreading the deduction through “capitalization”, “amortization” or “depreciation”. 

Personal Expenses

As a small business owner, you can’t use personal expenses to reduce business income. Don’t risk losing out on valuable tax deductions and be sure to separate personal from business expenses. Keep in mind though, that an exception can only matter when an expense is used for both business and personal reasons. 

Let’s take this as an example. You borrowed money and used 60 percent of it for business, while the other 40 percent for a family vacation. Given this, you can deduct 60 percent of the interest as a business expense. 

Home Business Use

Small home-based business owners can claim the deduction whether they’re a homeowner or a renter, and you can use the deduction for any type of home. Regardless of your home type, you can be qualified for a tax deduction as long as it meets the criteria ​​of regular and exclusive use and be the principal place of your business.

There are two ways how you can determine the amount of your home tax deduction:  the simplified or regular method.

  • Simplified method.

As the name suggests, this one can spare you time and a headache. This method works like this: the square footage of your space is multiplied by a prescribed rate. The rate is $5 per square foot for up to 300 square feet of space.

  • Regular method.

Using the regular method can be time-consuming. It involves determining the actual expenses for the space, which may include but are not limited to the mortgage interest, insurance, utilities, repairs, and depreciation. It means that you need to measure actual expenditures against your overall residence expenses.

Key Takeaway

Being a business owner and running your own business at home, tax deductions can be of great help. Whatever you do, make sure to keep detailed records of all of your expenses so you can back up your deductions in case of an audit. Consult with a tax advisor or use the appropriate online tax software if you’re unsure about how to proceed.

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