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Taxes

What is the Home-Based Business Definition?

Stephen Fishman
Tax expert and contributor MileIQ
September 9, 2015

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Vast numbers of small business owners run their businesses from home. This will not only save money on office rent but can also qualify you to take the home office deduction on your taxes. However, there can be some legal impediments to working from home.

It’s a business whose primary office is in the owner’s home. This business can be any size or any type as long as the office itself is in the home.

Legal Restrictions on Working at Home

If you decide to work at home, you may have issues with local zoning laws, use restrictions in your lease or condominium rules. You should investigate these potential problems before you open your home office. Even if your community is unfriendly to home offices, there are many things you can do to avoid problems before they arise.

Zoning restrictions

Municipalities have the legal right to establish rules on the types of activities you can conduct in their different geographical areas. For example, they often establish commercial zones for stores and offices, industrial zones for factories and residential zones for houses and apartments.

Though some communities have no zoning restrictions at all (for example, Houston), most do. These restrictions often include laws that limit the kind of business you can conduct in a residential zone. The purpose of these restrictions is to help maintain the peace and quiet of residential neighborhoods.

Fortunately, while some communities remain hostile to home businesses, the growing trend across the country is to permit them. Many cities have updated their zoning laws to permit many home businesses.

Your first step to determine whether you might have a problem working at home is to read your local zoning ordinance carefully. Get a copy from your city’s or county’s website, your city or county clerk’s office or your public library.

What Do Zoning Ordinances Say About Home-Based Businesses?

Zoning ordinances that limit businesses in residential areas are worded in many different ways. Some are extremely vague, allowing “customary home-based occupations.” Others allow homeowners to use their houses for a wide but unspecific array of business purposes, such as “professions and domestic occupations, crafts and services.” Still, others contain a detailed list of approved occupations, such as “law, dentistry, medicine, music lessons, photography [and] cabinetmaking.”

Ordinances permitting home-based businesses typically include detailed regulations on how to carry out business activities. These regulations vary widely, but the most common ones limit your use of on-street signs, car and truck traffic, and the number of employees who can work at your house on a regular basis (some prohibit employees altogether).

Some ordinances also limit the percentage of your home’s floor space that you can devote to your business. Study your ordinance carefully to see how these rules apply to you. If you still aren’t sure whether your business is allowed, you may be tempted to discuss the matter with zoning or planning officials. However, until you figure out the rules and politics of your locality, gather information without identifying or calling attention to yourself. For example, have a friend who lives nearby make general inquiries.

Even if your locality has restrictive zoning laws, you won’t necessarily have problems with your home business. In most communities, such laws are rarely enforced unless one of your neighbors complains to local officials. Neighbors usually complain because you make a lot of noise or have large numbers of clients, employees or delivery people coming and going, causing parking or traffic problems. If you’re an unobtrusive-for example, you work quietly in your home office all day and rarely receive business visitors-it’s unlikely that your neighbors will complain (or even notice).

Homeowners’ association rules

One in six Americans lives in a planned community that has a homeowners’ association. When you buy property in such a development, you automatically become a member of the homeowners’ association. You
 also become subject to its rules, which are usually set forth in a lengthy document called “covenants, conditions, and restrictions” (CC&Rs). CC&Rs often regulate, in minute detail, what you can do on, in and to your property. The homeowners’ association is in charge of modifying and enforcing these rules.

The CC&Rs for many developments specifically bar home-based business offices. The homeowners’ association may be able to impose fines and other penalties against you if your home business violates the rules. It could also sue you in court to get money damages or other penalties. Some homeowners’ associations are very strict about enforcing their rules against home businesses while others are less so.

Carefully study the CC&Rs before you buy into a condominium, planned development or cooperative to see if home-based business offices are prohibited. If so, you may want to buy somewhere else.

If you’re already in a development that bars home-based business offices, you may be able to avoid problems if you’re unobtrusive and your neighbors are unaware that you have a home office. However, the best course may be to seek to change the CC&Rs. Most homeowner associations rule through
 a board of directors whose members are elected by all the members of the association. Lobby members of the board about changing the rules to permit home offices. If that fails, you and like-minded neighbors could try to get seats on the board and gain a voice in the association’s policy making.

Lease restrictions

If you’re a renter, check your lease before you start your home business. Many standard lease forms prohibit a tenant from conducting a business on the premises or prohibit certain types of businesses. Your landlord could evict you if you violate such a lease provision.

Most landlords don’t want to evict their tenants. Many don’t care what you do on your premises as long as it doesn’t disturb your neighbors or cause damage. Keep up good neighbor relations to prevent complaints.

However, if you have business visitors, your landlord may require you to obtain liability insurance in case a visitor has an accident, such as a trip or fall on the premises.

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Home Office Deduction

If you use a dedicated workspace to run your business from home, the federal government allows you to deduct your home office expenses from your income taxes. This is so whether you own or rent your home. Although this tax deduction is commonly called the “home office deduction,” it is not limited to home offices. You can also take it if, for example, you have a workshop or studio at home.

Regular and exclusive business use

You can’t take the home office deduction unless you regularly use part of your home exclusively for a trade or business. Unfortunately, the IRS doesn’t offer a clear definition of “regular use.” The only guidance the agency offers is that you must use a portion of
 your home for business on a continuing basis, not just for occasional or incidental business. You’ll likely satisfy this test if you use your home office a few hours each day.

“Exclusive use” means that you use a portion of your home only for business. If you use part of your home as your business office and also use 
that part for personal purposes, you cannot meet the test of exclusive use and cannot take the home office deduction. You needn’t devote an entirely separate room in your home to your business. But some part of the room must be used exclusively for business.

Qualifying for the deduction

Unfortunately, satisfying the requirement of using your home office regularly and exclusively for business is only half the battle. You must also meet one of these three requirements:

  • Your home office must be your principal place of business.
  • You must meet clients or customers at home.
  • A separate structure on your property must be used exclusively for business purposes.

Amount of deduction

To figure out the amount of the home office deduction you need to determine what percentage of your home you use for business. To do this, divide the square footage of your home office by the total square footage of your home. For example, if your home is 1,600 square feet and you use 400 square feet for your home office, you use 25 percent of the total area for business.

The home office deduction is not one deduction, but many. First, you are entitled to deduct from your gross income the percentage you use for your home office of:

  • your rent if you rent your home, or
  • depreciation, mortgage interest, and property taxes if you own your home.

In addition, you may deduct this same percentage of other expenses

for keeping up and running an entire home. The IRS calls these indirect expenses. They include:

  • utility expenses for electricity, gas, heat, and trash removal
  • homeowner’s or renter’s insurance
  • home maintenance expenses that benefit your entire home, including your home office (for example, roof and furnace repairs or exterior painting)
  • condominium association fees
  • snow removal expenses
  • casualty losses if your home is damaged (for example, in a storm), and
  • security system costs.

You may also deduct the entire cost of expenses solely for your home office. The IRS calls these direct expenses. They include, for example, painting your home office or paying someone to clean it. If you pay a housekeeper to clean your entire house, you may deduct your business use percentage of the expense.

Example: Jean rents a 1,600-square-foot apartment and uses a 400-square-foot room as a home office for her consulting business. Her percentage of business use is 25 percent (400 ÷ 1,600). She pays $12,000 in annual rent and has a $1,200 utility bill for the year. She also spent $200 to paint her home office. She is entitled to deduct 25 percent of her rent and utilities ($3,300) plus the entire cost of painting her office, for a total home office deduction of $3,500.

Be sure to keep copies of all your bills and receipts for home office expenses.

The home office deduction can be very valuable if you’re a renter because you get to deduct part of your rent: a substantial expense that is not ordinarily deductible. If you own your home, the home office deduction is worthless because you’re already allowed to deduct your mortgage interest and property taxes from your income tax. But taking the home office deduction will allow you to deduct these items from your self-employment taxes. You’ll save $153 in self-employment taxes for every $1,000 in mortgage interest and property taxes you deduct. You’ll also be able to deduct a portion of repairs, utility bills, cleaning and maintenance costs, and depreciation.

Optional Simplified Home Office Deduction Method

You have the option of using a much simpler method to calculate your home office deduction. Using this method, you just deduct $5 for every square foot of your home office. All you need do is get out your measuring tape. For example, if your home office is 200 square feet, you’ll get a $1,000 home office deduction. That’s all there is to it

Profit Limit for Deductions

There is an important limitation on taking the home office deduction: It may not exceed the net profit you earn from your home office in that year. If you run a successful business out of your home office, this limitation isn’t a problem, because your profits will exceed your deductions. But if your business earns very little money or even loses money, this could prevent you from deducting part or all of your home office expenses in a given year.

If your deductions exceed your profits in a particular year, you can, however, deduct this excess in the following year and in each succeeding year until you deduct the entire amount. There is no limit on how far into the future you can deduct these expenses: You can claim them even if you are no longer living in the home where they were incurred.

So, whether or not your business is making money, you should keep track of your home office expenses and claim the deduction on your
 tax return.

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Vast numbers of small business owners run their businesses from home. This will not only save money on office rent but can also qualify you to take the home office deduction on your taxes. However, there can be some legal impediments to working from home.

It’s a business whose primary office is in the owner’s home. This business can be any size or any type as long as the office itself is in the home.

Legal Restrictions on Working at Home

If you decide to work at home, you may have issues with local zoning laws, use restrictions in your lease or condominium rules. You should investigate these potential problems before you open your home office. Even if your community is unfriendly to home offices, there are many things you can do to avoid problems before they arise.

Zoning restrictions

Municipalities have the legal right to establish rules on the types of activities you can conduct in their different geographical areas. For example, they often establish commercial zones for stores and offices, industrial zones for factories and residential zones for houses and apartments.

Though some communities have no zoning restrictions at all (for example, Houston), most do. These restrictions often include laws that limit the kind of business you can conduct in a residential zone. The purpose of these restrictions is to help maintain the peace and quiet of residential neighborhoods.

Fortunately, while some communities remain hostile to home businesses, the growing trend across the country is to permit them. Many cities have updated their zoning laws to permit many home businesses.

Your first step to determine whether you might have a problem working at home is to read your local zoning ordinance carefully. Get a copy from your city’s or county’s website, your city or county clerk’s office or your public library.

What Do Zoning Ordinances Say About Home-Based Businesses?

Zoning ordinances that limit businesses in residential areas are worded in many different ways. Some are extremely vague, allowing “customary home-based occupations.” Others allow homeowners to use their houses for a wide but unspecific array of business purposes, such as “professions and domestic occupations, crafts and services.” Still, others contain a detailed list of approved occupations, such as “law, dentistry, medicine, music lessons, photography [and] cabinetmaking.”

Ordinances permitting home-based businesses typically include detailed regulations on how to carry out business activities. These regulations vary widely, but the most common ones limit your use of on-street signs, car and truck traffic, and the number of employees who can work at your house on a regular basis (some prohibit employees altogether).

Some ordinances also limit the percentage of your home’s floor space that you can devote to your business. Study your ordinance carefully to see how these rules apply to you. If you still aren’t sure whether your business is allowed, you may be tempted to discuss the matter with zoning or planning officials. However, until you figure out the rules and politics of your locality, gather information without identifying or calling attention to yourself. For example, have a friend who lives nearby make general inquiries.

Even if your locality has restrictive zoning laws, you won’t necessarily have problems with your home business. In most communities, such laws are rarely enforced unless one of your neighbors complains to local officials. Neighbors usually complain because you make a lot of noise or have large numbers of clients, employees or delivery people coming and going, causing parking or traffic problems. If you’re an unobtrusive-for example, you work quietly in your home office all day and rarely receive business visitors-it’s unlikely that your neighbors will complain (or even notice).

Homeowners’ association rules

One in six Americans lives in a planned community that has a homeowners’ association. When you buy property in such a development, you automatically become a member of the homeowners’ association. You
 also become subject to its rules, which are usually set forth in a lengthy document called “covenants, conditions, and restrictions” (CC&Rs). CC&Rs often regulate, in minute detail, what you can do on, in and to your property. The homeowners’ association is in charge of modifying and enforcing these rules.

The CC&Rs for many developments specifically bar home-based business offices. The homeowners’ association may be able to impose fines and other penalties against you if your home business violates the rules. It could also sue you in court to get money damages or other penalties. Some homeowners’ associations are very strict about enforcing their rules against home businesses while others are less so.

Carefully study the CC&Rs before you buy into a condominium, planned development or cooperative to see if home-based business offices are prohibited. If so, you may want to buy somewhere else.

If you’re already in a development that bars home-based business offices, you may be able to avoid problems if you’re unobtrusive and your neighbors are unaware that you have a home office. However, the best course may be to seek to change the CC&Rs. Most homeowner associations rule through
 a board of directors whose members are elected by all the members of the association. Lobby members of the board about changing the rules to permit home offices. If that fails, you and like-minded neighbors could try to get seats on the board and gain a voice in the association’s policy making.

Lease restrictions

If you’re a renter, check your lease before you start your home business. Many standard lease forms prohibit a tenant from conducting a business on the premises or prohibit certain types of businesses. Your landlord could evict you if you violate such a lease provision.

Most landlords don’t want to evict their tenants. Many don’t care what you do on your premises as long as it doesn’t disturb your neighbors or cause damage. Keep up good neighbor relations to prevent complaints.

However, if you have business visitors, your landlord may require you to obtain liability insurance in case a visitor has an accident, such as a trip or fall on the premises.

Home Office Deduction

If you use a dedicated workspace to run your business from home, the federal government allows you to deduct your home office expenses from your income taxes. This is so whether you own or rent your home. Although this tax deduction is commonly called the “home office deduction,” it is not limited to home offices. You can also take it if, for example, you have a workshop or studio at home.

Regular and exclusive business use

You can’t take the home office deduction unless you regularly use part of your home exclusively for a trade or business. Unfortunately, the IRS doesn’t offer a clear definition of “regular use.” The only guidance the agency offers is that you must use a portion of
 your home for business on a continuing basis, not just for occasional or incidental business. You’ll likely satisfy this test if you use your home office a few hours each day.

“Exclusive use” means that you use a portion of your home only for business. If you use part of your home as your business office and also use 
that part for personal purposes, you cannot meet the test of exclusive use and cannot take the home office deduction. You needn’t devote an entirely separate room in your home to your business. But some part of the room must be used exclusively for business.

Qualifying for the deduction

Unfortunately, satisfying the requirement of using your home office regularly and exclusively for business is only half the battle. You must also meet one of these three requirements:

  • Your home office must be your principal place of business.
  • You must meet clients or customers at home.
  • A separate structure on your property must be used exclusively for business purposes.

Amount of deduction

To figure out the amount of the home office deduction you need to determine what percentage of your home you use for business. To do this, divide the square footage of your home office by the total square footage of your home. For example, if your home is 1,600 square feet and you use 400 square feet for your home office, you use 25 percent of the total area for business.

The home office deduction is not one deduction, but many. First, you are entitled to deduct from your gross income the percentage you use for your home office of:

  • your rent if you rent your home, or
  • depreciation, mortgage interest, and property taxes if you own your home.

In addition, you may deduct this same percentage of other expenses

for keeping up and running an entire home. The IRS calls these indirect expenses. They include:

  • utility expenses for electricity, gas, heat, and trash removal
  • homeowner’s or renter’s insurance
  • home maintenance expenses that benefit your entire home, including your home office (for example, roof and furnace repairs or exterior painting)
  • condominium association fees
  • snow removal expenses
  • casualty losses if your home is damaged (for example, in a storm), and
  • security system costs.

You may also deduct the entire cost of expenses solely for your home office. The IRS calls these direct expenses. They include, for example, painting your home office or paying someone to clean it. If you pay a housekeeper to clean your entire house, you may deduct your business use percentage of the expense.

Example: Jean rents a 1,600-square-foot apartment and uses a 400-square-foot room as a home office for her consulting business. Her percentage of business use is 25 percent (400 ÷ 1,600). She pays $12,000 in annual rent and has a $1,200 utility bill for the year. She also spent $200 to paint her home office. She is entitled to deduct 25 percent of her rent and utilities ($3,300) plus the entire cost of painting her office, for a total home office deduction of $3,500.

Be sure to keep copies of all your bills and receipts for home office expenses.

The home office deduction can be very valuable if you’re a renter because you get to deduct part of your rent: a substantial expense that is not ordinarily deductible. If you own your home, the home office deduction is worthless because you’re already allowed to deduct your mortgage interest and property taxes from your income tax. But taking the home office deduction will allow you to deduct these items from your self-employment taxes. You’ll save $153 in self-employment taxes for every $1,000 in mortgage interest and property taxes you deduct. You’ll also be able to deduct a portion of repairs, utility bills, cleaning and maintenance costs, and depreciation.

Optional Simplified Home Office Deduction Method

You have the option of using a much simpler method to calculate your home office deduction. Using this method, you just deduct $5 for every square foot of your home office. All you need do is get out your measuring tape. For example, if your home office is 200 square feet, you’ll get a $1,000 home office deduction. That’s all there is to it

Profit Limit for Deductions

There is an important limitation on taking the home office deduction: It may not exceed the net profit you earn from your home office in that year. If you run a successful business out of your home office, this limitation isn’t a problem, because your profits will exceed your deductions. But if your business earns very little money or even loses money, this could prevent you from deducting part or all of your home office expenses in a given year.

If your deductions exceed your profits in a particular year, you can, however, deduct this excess in the following year and in each succeeding year until you deduct the entire amount. There is no limit on how far into the future you can deduct these expenses: You can claim them even if you are no longer living in the home where they were incurred.

So, whether or not your business is making money, you should keep track of your home office expenses and claim the deduction on your
 tax return.

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