eRank does not provide tax, legal or accounting advice. This material has been prepared for informational purposes only, and is not intended to provide, and should not be relied on for, tax, legal or accounting advice. You should consult your own tax, legal and accounting advisors.
This information applies to crafters in the United States of America (USA). However, crafters in other countries might find this information useful.
Start your Etsy shop craft business. Check. Turn your spare bedroom into your dream craft room. Check. Do your US annual tax return. Uh-oh! Is your new craft room deductible?
Many US crafters wonder if the craft room that they use to run their home-based business is tax deductible. The answer is often yes! To qualify, the space must be used regularly and exclusively to conduct the home business AND be considered your primary place of business. If you can answer yes to both these requirements, please read on.
Two Deduction Options
When using the home office deduction, two options exist: the simplified option and the regular method. For the simplified option, calculate the square footage of your craft room and multiply it by that year’s rate, which for 2021 is $5 a square foot with a maximum deduction of $1500 (300 square feet). If your craft room is 100 square feet, your deduction is $500. This option is a quick and easy calculation and allows you to recognize a deduction to help lower the amount of tax you owe.
However, itemizing with the standard method is often a higher home office deduction amount. Either way, you must calculate the square footage of your craft room. With the standard method, also calculate the total square footage of your house. Divide the total square footage of your craft room by the total square footage of your house to find the percentage of home expenses that you can deduct.
For example, if your craft room is 100 square feet and your house is 1800 square feet, you can deduct 5.6% of your home expenses. This is your home office deduction (HOD) percentage (also known as HOD%).
100 / 1800 = 0.056 or 5.6%
Included Home Expenses
The major home office expenses can be grouped into five expense categories. The expense categories are utilities, taxes (property), repairs, insurance, and mortgage interest / rent. To easily recall these five categories, remember that the home office deduction is “trimming” the amount of tax you owe or UTRIM.
- Utilities – Utilities include your home’s electric, water, and gas expenses. Calculate what you paid for these items for the entire year and multiply by your HOD%. If you paid $3600 in expenses, you can deduct $202.
- Taxes (Property) – This category only applies to crafters that own their homes. Your annual property tax amount is for your entire residence. Therefore, multiply the tax amount by your HOD% for the amount to include for your home office. Annual property taxes of $800 gives you a $45 deduction.
- Repairs – Any repairs performed directly to your craft room space are 100% deductible such as painting, flooring, lighting, and shelving. But did you know that a percentage of any repair to your home that affects the entire house is also deductible as part of your home office deduction? Did you repair a leaky roof or maybe your AC unit? Think about what repairs that you completed to your home during the year and multiply by the HOD%. Let’s use $1000 in repairs, which results in a $56 deduction.
- Insurance – If you own your home, you have homeowner’s insurance and maybe mortgage insurance. If you rent, you have renter’s insurance. Multiple the annual insurance premium by your HOD% and voila! You have your next deduction amount. For example, let’s use $1200 a year in insurance for a $67 deduction amount.
- Mortgage Interest / Rent – Do you pay monthly mortgage payments or a monthly rent amount? Multiply your annual interest portion of the mortgage payment or your annual rent amount by the HOD%. For our example, let’s use $6000 as the amount of mortgage interest paid for the year, which calculates to a $336 deduction for this category.
NOTE: If your business requires the internet, it is also a utility. However, the calculation for it is a bit different. You must calculate how much home internet usage is business-related and how much is personal entertainment-related. Currently, the IRS does not have a formula to calculate the deduction for internet use. However, some accounting professionals use 25% of your total internet expense as a general rule.
Comparison
In our example, the simplified option for a 100 square foot craft room results in a $500 home office deduction. That same 100 square foot craft room using the standard method and the five expense categories above allows a $706 deduction. For this example, the standard method results in a slightly higher home office deduction amount.
The benefit to understanding both options is that you are allowed to change from year to year. One year, the simplified option may be the best deduction amount, and the next year, the standard method may be the best. If you have the time, it is worth calculating both. However, if in a hurry, do not forget to at least deduct for your home office (if the space meets the requirements) using the simplified option.
For more information about the home office deduction, please refer to the Internal Revenue Service’s site (https://www.irs.gov/businesses/small-businesses-self-employed/home-office-deduction).
It is always best to speak with your personal tax accountant about your specific tax situation before filing your annual taxes. Remember Benjamin Franklin’s saying, “A penny saved is a penny earned.”
We hope you found this helpful as you prepare for tax season!
Michelle Badger, Accountant (25 + years) and Etsy seller