After you have determined the percentage of business use, you need to determine which expenses are directly related to business and which ones are indirectly related. This breakdown is reported in Part II of Form 8829 or in Part 2 of the worksheet in IRS Publication 587. You should also keep in mind that if you did not operate a business for the entire year, you can deduct expenses only for the portion of the year you used your home for business.
Direct expenses are those that benefit only the part of your home that is used for your trade or business. Direct expenses are 100% deductible. For example, if you have expenses for repairing or painting the specific area or rooms you use for business, these would be direct expenses.
Indirect expenses are for keeping up and running your entire home, including both the business and personal portions. On the tax form, you report 100% of these expenses and then apply the percentage you calculated for business use of your home to determine the portion of these overall expenses that apply to your business.
The types of expenses that need to be classified between direct and indirect include casualty losses, mortgage interest, real estate taxes, insurance, repairs and maintenance, utilities and other expenses.
For mortgage interest, include only the mortgage interest that would be deductible on Schedule A as an itemized deduction. For example, do not include interest on a home equity loan that you used to pay off credit card bills, buy a car, pay for college tuition or for some purpose other than to finance your home. This is personal interest and would not be deductible on Schedule A.
If you itemize deductions on Schedule A, be sure to include only the personal portion of the mortgage interest and real estate taxes, excluding the portion you claim as an indirect expense on either Form 8829 or the worksheet.
In the case of utilities, you can deduct the business percentage of electricity, gas, trash removal, and cleaning services. The base rate of the first telephone line into your home is considered a personal expense and cannot be deducted. But if you make business calls on this line or if you have a second line installed and use it exclusively for business, these expenses are deductible. But they are direct expenses that would be reported on Schedule C as a business expenses, or as an itemized deduction in the case of employee business expenses, and should not be included in expenses for business use of your home.