Deducting the Cost of Utilities as Part of Your Home Office Deduction
Post #27: Calculate how to deduct a portion of your utility bills (water, heat, cooling, electricity, etc...) from your small business income.
In this Substack, I will walk you through the process of starting, operating, maintaining, and — if needed — selling or closing your own small business.
Today, I am going to continue the discussion about using home office expenses as a deduction from your business income to save money on your annual income taxes, with a focus on deducting a portion of your utility bills.
As a small business owner or freelancer utilizing a portion of your home exclusively and regularly for business purposes, you may be eligible to deduct a portion of your home utilities through the home office deduction.
This can lead to significant tax savings by offsetting business income with a share of your household expenses.
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A quick refresher…
Can You Deduct Home Office Expenses?
Before we dive into this topic, let’s review the relevant highlights from my previous post on how to maximize home office deductions.
Who Qualifies for the Home Office Deduction?
The home office deduction is available to self-employed individuals, independent contractors, and small business owners who use a portion of their home regularly and exclusively for business purposes. (Review this in more detail here)
If you only work from home occasionally, use the space for both personal and business activities, or are a remote employee who works for someone else, you do not qualify. (Learn why here)
Methods for Calculating This Deduction (per the IRS)
The U.S. Internal Revenue Service defines two methods to calculate the home office deduction:
Simplified Method – With this method, a flat rate of $5 per square foot of home office space (up to 300 square feet) can be deducted from your expenses.
Regular Method (a.k.a.: the Actual Expenses Method) - This method, which allows you to deduct actual expenses (such as mortgage interest or rent), is calculated by determining the percentage of your eligible home expenses based on the square footage of your home office relative to your entire home.
Let’s dive into how to apply the actual expenses method specifically for utility bills.
Deductible Utilities Expenses
The U.S. Internal Revenue Service (IRS) allows qualified individuals and small business owners to deduct specific utility expenses that are associated with maintaining a home office.
These typically include:
Electricity: Powering your workspace.
Heating and Cooling: Maintaining a comfortable environment.
Water and Sewer: Basic utilities necessary for the property's operation.
Trash Collection: Regular waste management services.
💡 Tip: While often considered a “utility bill”, I will address these additional types of expenses in a future post:
Internet Service: Essential for business operations.
Landline Phone: If dedicated exclusively to business use.
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Non-Deductible Utility Expenses
The IRS does not allow deductions for expenses if they are not directly related to the business use of your home.
For example, these expenses are typically not deductible because they are considered “personal services” and are not necessary for conducting business in your home:
family-shared phone line
cable television
streaming video services (Netflix, Hulu, etc.)
Keep in mind that your business may be an exception to this guideline if you use these services in your line of work (e.g.: if you use the phone line for business calls while working from home, work in the streaming video or cable television production industry, or serve as an independent contractor for Netflix’s corporate offices, you may qualify to deduct at least a portion of these bills).
Calculating Your Utility Bill Deduction
As part of your overall home office deduction, calculating the amount that you can deduct from your utility bills is quite simple.
For each utility bill, find the total bill amount.
For example, let’s say your electricity bill is on average $100 across the entire calendar year (January through December).
Recall the percentage of space your home office occupies in your home.
For example, let’s say your home office is 10% of your home.
Multiply the total utility bill that you pay by the percentage of space your home office occupies.
For example, you pay $100 per month x 10% = $10 per month ($120 per year)
💡 Tip: if you have roommates, you would simply use the amount of the utility that YOU paid - not the whole bill - for step #1 in this calculation.
Keep reading for more details…
Splitting the Bills with Roommates
If you share your residence with roommates and pay rent, you can still deduct a portion of your home office expenses. To do so, you must meet the exclusive and regular use criteria (as I mentioned, above).
Specifically:
Exclusive Use: Ensure the space is used solely for your business activities.
Regular Use: Use the space consistently for business purposes.
Calculation: Determine your portion of shared expenses based on your rental agreement.
For example, if you and a roommate split rent and utilities equally, and your home office occupies 10% of the home's space, you can deduct 10% of your share of these expenses.
💡 Tip: Review my previous post for more information about how to calculate your home office space when you share your space with roommates.
Keep Good Records
Good record-keeping will always be your “best friend”, when it comes to operating your own small business, and deducting a portion of your utility bills as part of the home office expenses is no exception.
So, be sure to:
Maintain Detailed Records: Keep accurate records of all utility bills and calculations used to determine the deductible portion.
Document Your Home Office Space: Retain evidence, such as photographs or a floor plan, demonstrating the exclusive business use of the space.
Stay Organized: Keep your workspace contained in the area that you have designated for your business, if possible.
Avoid These Red Flags for IRS Audits
No one wants to get that scary letter in the mail from the IRS informing you that your business has been selected for an audit. 😱
⚡ WARNING! ⚡
Don’t be afraid of the IRS.
If you are following the rules, you are perfectly right to take these deductions!
Too many business owners overpay their taxes because they are unfamiliar with these guidelines and are too afraid of an IRS audit (despite their eligibility to take these deductions).
You can survive - or ‘win’ - an IRS audit when you can demonstrate that you are following the IRS guidelines and have the evidence to show it.
Avoid these common mistakes to reduce the likelihood of an IRS audit:
Inaccurate Space Allocation: Claiming an unreasonably large portion of your home as a business area.
Lack of Exclusive Use: Using the designated home office space for personal activities.
Insufficient Documentation: Failing to maintain records supporting your deduction claims.
By adhering to IRS guidelines and maintaining thorough documentation, you can confidently claim a portion of your utility expenses for the home office deduction, and reduce your taxable income.
Next Steps
In the next post, I am going to write about deducting Internet and Phone Bills (i.e.: the portions used for business) as part of your home office expenses.
With the prevalence of the internet and necessity of a mobile phone, these bills can get really big!
So, why not deduct what you can?
👉 Continue the Journey with Post #28 —>
