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Although it may not seem like it, the IRS is not out to make tax preparation as difficult as possible for you. If you make errors, it causes them headaches, too. That’s why they try to accommodate your reasonably documented calculations for home office deductions. According to the IRS in its home office deductions publication, “You can use any reasonable method to determine the business percentage” of your residence[1].
Methods Suggested by the IRS
In that same publication, the IRS then goes on to suggest two methods that may be easy for small business owners to implement:
- Number of Rooms—This method is just what it sounds like. If all your rooms are approximately the same size, you can divide the number of rooms used for business purposes by the number of rooms in your house. It’s actually fairly simple; however, the calculations will be less precise than with methods in which you measure the size of your office space.
- Gross Square Footage—For a slightly more in depth calculation (but still relatively simple), you can calculate gross square footage. Multiply the office’s length by its width. Then, divide that number by the total area of your house.
Either of these methods works fine, but it turns out there’s a different calculation that may better benefit your finances.
Net Square Footage
When you calculate net square footage, you only calculate the useable portion of your home. It takes a little more figuring, but you’ll come up with a more accurate number that increases your deductions and save you money. How? Because when you take away from the calculations the parts of your home that cannot be used as office space, you reduce the denominator by which you’re dividing. And, that equals a greater percentage of your residence being considered business space.
Areas that are subtracted to find net square footage include bathrooms, stairways, hallways, outside walls, water heaters, foyers, and heating and cooling equipment. This method is used in cost accounting standards[2] and in commercial real estate[3]. This means you have documented standards for using net square footage to calculate assignable space in your home, since cost accounting standards are used with government grants and contracts.
As long as you keep accurate records, you’ll only have to make this calculation once—unless, of course, you move or change your office space. Tip: Simply measuring the square feet of each assignable room will give you the same number as taking out measurements for bathrooms, hallways, and other spaces that are not available for use.
Form 8829
Despite the fact that the IRS itself states any reasonable calculation method may be used, the IRS Form 8829 only shows an option for the gross square footage calculation[4]. Don’t let that fool you. The instructions for this form clearly specify that you may use other reasonable calculation methods so long as they accurately reflect your business percentage.
Let’s check out an example so you can see the benefit of taking a net square footage measurement. For the example, assume you have a 2,600 square-foot home with eight rooms, excluding bathrooms. When you subtract the common areas that are unassignable space, you have 2,000 useable square feet, of which your office takes up one, 270 square-foot room.
Calculating gross square footage, you divide 270 by 2,600, getting 10.38% business area. Calculating by number of rooms, you take 1 divided by 8 and end up with 12.5% business area. However, the net square footage method takes 270 divided by only 2,000, making your business area 13.5% of the total house.
Using the number of rooms method, you actually allot 20% more space to your office. But, using net square footage, you increase the office portion by 30% more than using gross square footage. As you can see, that can increase your deductions significantly when you consider that accounts for 30% more of your mortgage interest, property taxes, rent, insurance, utilities, pest control, maintenance and repairs that benefit the whole house, or depreciation.
If the IRS allows you multiple options for deducting home office expenses, it makes sense for you to explore them. Under the right circumstances, the number of rooms method can yield greater deductions than gross square footage, and it’s simple to use. But, net square footage will always increase your deductions over the gross square footage method. Make sure you consider your options and get the most tax savings possible!