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Running a day-care business out of your home can be a good way to create a job for yourself, especially if you like working with children. But at some point you're going to have to put on your business hat and deal with your income taxes. Home day care businesses have special tax rules, particularly when it comes to deducting expenses such as mortgage interest and property taxes.
Business Use of Home
Normally when you claim deductions for the business use of your home, you must have an area that you use exclusively for business -- you are not allowed to conduct any private activities in that space. But with home day cares, this is often impractical. What functions as the playroom during the day is your living room at night. To accommodate this reality, the IRS allows day-care providers an exception to the "exclusive use" rule, allowing you to calculate the business-use portion of your home on the basis of time as well as space.
To calculate your deduction for using your home as a day care, you must determine what percentage of your home is regularly used for day care during business hours. You can do your calculations using square footage, or you can simply go by the number of rooms if they are about the same size. For example, if you have eight rooms in your house, and you use four of them when caring for children, then 50 percent of your home is used for day care. This doesn't mean you have to use all four rooms every day, but it does mean you have to use them regularly, and they have to be available for use every day if you need them.
Calculate the percentage of time you use the rooms for day care. For example, if your day care is open five days a week for 12 hours each day, you use the rooms 60 hours each week. Since there are 164 hours in a week, you must divide 164 hours by 60 hours, giving you a result of .357, which translates to 35.7 percent.
Multiply the two numbers -- the percentage of space and the percentage of time -- to find the number you will use when calculating the deductible portion of your home expenses. For example, if you use 50 percent of your home 35.7 percent of the time, multiply .50 times .357, which will give you a result of 17.85 percent. This is the total business use of your home for day care.
Enter your total percentage on Form 8829, Expenses for Business Use of Your Home. On the form you will also enter the total amount of mortgage interest, property taxes, utilities and other expenses you incurred during the year. Once you have determined all of your home expenses, you will multiply this number by the percentage of business use to determine your deduction for business expenses. For example, if you paid $5,000 in mortgage interest, and the business use of your home was 17.85 percent, you will be able to deduct $892 of the mortgage interest as a business expense. The other $4,108 can be deducted on Schedule A as an itemized deduction.
In order to use the special day-care rules, you must actually be in the day-care trade or business. It can't just be something you do on an occasional basis. Also, your day care must comply with all state regulations and must have a license if required in your state. The day care can be for children, the elderly, or people with mental or physical disabilities.
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