Unique Issues for Speciﬁc Businesses – Accounting for Your Home-Based Business
Virtually every new business and small-business owner out there conducts at least some business from home. Among these are true home-based businesses, meaning there is no other ofﬁce or shop to work out of. When you work solely from home, it’s easy to forget that a lot of your household bills are really business expenses—or at least some portion of them are. You’ll ﬁnd that your business expenses will fall into one of two categories: completely business, or part business, part personal. Either way, you have to record the expenses as part of your ongoing bookkeeping.
Expenses that can be traced directly to the business can be recorded on your books as is. For example, if you repaint your ofﬁce, that’s a pure business expense. If you get a rider on your homeowner’s insurance policy covering your home ofﬁce and business equipment, the full cost of that rider is recorded by the company. When an expense crosses the line between business and personal, such as a security system that covers the whole house, you’ll have to ﬁgure out what portion of that expense belongs to the business (see the next section for how to do that).
The IRS often pays close attention to the home-related expenses of home-based businesses. It’s an area that a lot of people have trouble calculating correctly, making it a prime target for tax return revision. Because of this, it’s doubly important that you document business-only expenses that could be mistaken for household expenses, and make sure combined expense allocations make sense.
The IRS has special rules concerning the deductibility of home work spaces. When your home is your only work space, though, it’s easier to justify deductions should the need arise. The main rule that trips people up is this: The space has to be used regularly and exclusively for business. It’s the “exclusively” that causes the most problems; that means you can’t use the space for anything but business.
Accounting for Shared Expenses
When you work from home, some of your regular household expenses turn into business expenses as well. Any expenditure that beneﬁts both your living space and your workspace is considered an indirect expense; these include things such as electricity and real estate taxes.
To ﬁgure out the portion that’s deductible for business purposes, you can use a simple ratio. Measure the space you use for your work area, either in square feet or number of rooms (whatever makes sense), and divide that by the space in your whole house. For example, if you have a four-room apartment and use one room exclusively for business, you would use one- fourth as your ratio. Then apply that ratio to each shared expense to come up with the business portion. If the electric bill for that four-room apartment came to $100, you can record $25 as a business expense.
The journal entry here depends on how you paid the expense. If you paid the entire bill with a personal check, your journal entry includes a debit to the applicable expense account and a credit to owner’s equity; paying business expenses with a personal check counts as a capital contribution. If you used two separate checks to pay the bill (a personal check for the personal portion, and a company check for the business portion), you record your journal entry just like any other cash disbursement: debit expense and credit cash.
Phone bills are the exception to the shared expense rules. If you have only one phone line in the house, it’s considered 100 percent personal. You can still deduct specific business calls, but not any of the general phone line expenses.
The Depreciation Deduction
When you own your home and have a home-based business, you have to record depreciation for the business portion of your home. That’s right: When you use your home for business, you are required to take depreciation. When you eventually sell that home, the portion used for business will count as the sale of business property. Even if you’ve never deducted depreciation, the IRS will act as if you did when recomputing any possible gain on the sale of your “business property.” Since you’ll have to pay that tax at some point (real estate values tend to go up), you may as well beneﬁt from the tax deduction now.
To calculate the depreciation, you have to know both the fair market value of your home and how much you paid for it plus the cost of any improvements you’ve made over the years. The smaller of those two values will be the basis of your depreciation calculation. From that number, deduct the value of land included in the value of your home to get just the building portion (land never gets depreciated, so you have to subtract it). The next step is to multiply that building basis by the IRS depreciation percentage
When you have calculated your current depreciation expense, record a regular depreciation journal entry. That includes a debit to depreciation expense and a credit to accumulated depreciation.