The general rule with home office deductions is that the deduction cannot generate a business loss. But there’s an exception to this rule.
If you own your house and pay a mortgage or property taxes, the portion of the deduction pertaining to those two items CAN result in a business loss. The portion of the deduction pertaining to utilities, insurance, depreciation, etc. CANNOT result in a business loss.
Example
Joe the Window Washer runs a sole proprietorship out of his home. The proprietorship’s net income (not including the home office deduction) is $1,000.
Based on the square footage of his office, Joe’s deduction for mortgage interest and property taxes comes to $1,500. Other expenses (utilities and depreciation) total $1,000.
The $1,500 of mortgage interest and property taxes are fully deductible, producing a business loss of $500 ($1,000 of net income minus $1,500).
The other $1,000 of home-office expenses for utilities and depreciation are not currently deductible. Instead, the deduction for those items gets carried forward to future years, where they can be taken as a business deduction if there’s enough business income.