Clients should note that we did not say it is any easier to claim the home office deduction. It is, however, much easier to calculate once you meet the qualifications for a home office.
As more people telecommute from home and people who lost jobs in the recession start businesses in their homes, it is a good time to revisit the tax rules that apply when people work from their homes. The rules to qualify are different for employees than for the self-employed, as are the places used for claiming the deduction on a tax return.
The IRS recently announced a safe-harbor method that will make it easier for those who choose the new method to take the deduction.
Rather than use the cumbersome old method (explained in great detail below), the use of the safe-harbor calculation is a comparative breeze.
Here’s how it works:
You can deduct an amount determined by multiplying the allowable square footage by $5. The allowable square footage is the portion of the house used in a qualified business use, but not to exceed 300 square feet. Therefore, the maximum a taxpayer can deduct annually under the safe harbor is $1,500. The IRS may update the $5 allowance from time to time, but it is not inflation adjusted. Because the up-to-$1,500 amount is a safe harbor, taxpayers who use the safe harbor cannot also deduct actual expenses related to qualified business use of the home for that year; however, business expenses that are unrelated to the use of the home (such as advertising) can be deducted.
No depreciation is allowed for the years in which the safe harbor is elected. This may make this method more attractive for taxpayers who do not plan to stay in their homes a long time because they will then avoid the depreciation recapture that is required of taxpayers who took depreciation on their personal residences.
Those wanting the technical details on how to qualify for this tax break should click the “show more” link below.
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The information below is summarized from the Journal of Accountancy July 2013.
CALCULATING THE AMOUNT OF THE DEDUCTION
Calculating the home office deduction can be done one of two ways: the actual-expense method, under which the home office deduction amount is based on the actual expenses related to the use of the home office incurred by the taxpayer, or the new safe-harbor method, under which the deduction amount is determined by a formula based on the square footage used as a home office.
Whichever method is used to calculate the deduction, the amount of the deduction is subject to a gross income limitation, which, as discussed below, is calculated differently for each method. In addition, the carryforward rules for the deduction are different under each method. Under the actual-expense method, any excess of otherwise deductible expenses over the gross income limitation can be carried forward to the next tax year, subject to the same limitation (Sec. 280A(c)(5)). If the safe-harbor method is used, the amount of otherwise deductible expenses in excess of the limitation cannot be carried forward to future tax years.
Under the actual-expense method, taxpayers first must determine the percentage of their home that is used for business. This can be done by any reasonable method, but the most common approaches are either (1) the square-footage approach, in which the area used for business is divided by the house’s total square feet, or, (2) if the rooms in the home are all of a similar size, determining the percentage by dividing the number of rooms used for business by the total number of rooms in the house. For example, using the first method, a taxpayer whose office is 12 feet by 15 feet and whose house is 2,000 square feet uses 9% of the house in the trade or business.
After determining the percentage of the home expenses that the taxpayer can deduct as expenses for the business use of his or her home, the next step is to determine whether the deduction is subject to the gross income limitation. The deduction of otherwise nondeductible home expenses, such as insurance, utilities, and depreciation (with depreciation taken last), that are allocable to the business, is limited to the gross income from the business use of the taxpayer’s home, less:
- The business part of expenses the taxpayer could deduct even if he or she did not use the home for business (such as mortgage interest, real estate taxes, and casualty and theft losses that are allowable as itemized deductions on Schedule A, Itemized Deductions (Form 1040)); and
- The business expenses that relate to the business activity in the home (e.g., business phone, supplies, and depreciation on equipment), but not to the use of the home itself. Self-employed taxpayers cannot include their deduction for the deductible part of their self-employment tax as expenses in the second category.
Here’s what the Journal has to say about the basic requirements to claim the deduction under either the old or new method.
THE STATUTORY REQUIREMENTS
“A deduction is permitted for expenses associated with that portion of the dwelling unit that is exclusively used on a regular basis either (1) as the principal place of business for any trade or business of the taxpayer; (2) as a place of business that is used by patients, clients, or customers in meeting or dealing with the taxpayer in the normal course of his or her trade or business; or (3) in the case of a separate structure that is not attached to the dwelling unit, in connection with the taxpayer’s trade or business.
For purposes of (1) above, the term “principal place of business” includes a place of business that the taxpayer uses for the administrative or management activities of the taxpayer’s trade or business if there is no other fixed location for the trade or business where the taxpayer conducts the substantial administrative or management activities (Sec. 280A(c)(1), flush language).
For the use of a home office by an employee to qualify, the use must be for the convenience of his or her employer (Sec. 280A(c)(1), flush language). Also, if the employee rents a portion of his or her home to the employer and uses the rented space to perform services as an employee for that employer, the employee cannot take a home office deduction for expenses related to that part of the employee’s home (Sec. 280A(c)(6)).
EXCLUSIVE USE ON A REGULAR BASIS
According to the IRS, to qualify for the “exclusive use” test, taxpayers must use a specific area of their home exclusively for their trade or business, but the area does not need to be set off by a permanent partition. However, it must be used for the trade or business exclusively and at all times (not just during business hours), and any use of the space for nonbusiness purposes disqualifies the area, e.g., an office that is also used as a family room will not qualify. So, for example, where an accountant’s children and guests occasionally used the bathroom and hallway adjacent to his home office (and built for the use of his clients), that portion of the house did not qualify for the home office deduction (Bulas, T.C. Memo. 2011-201).
To qualify for regular use, the specific area of the home must be used on a regular basis; occasional or incidental use will not qualify. This determination is made based on all the facts and circumstances (see Publication 587, Business Use of Your Home (Including Use by Daycare Providers)).
WORK AT HOME IS FOR THE EMPLOYER’S CONVENIENCE, NOT THE EMPLOYEE’S
Many employees who work in their homes will not qualify for the deduction because they do it for their own convenience, not their employer’s.
It is not impossible to establish that the home office is for the employer’s, not the employee’s, convenience, but it is difficult.
If the use of the home office is necessary to allow the employee to perform his or her duties as an employee properly, or the use of the home office is necessary for the functioning of the employer’s business, it will be considered to be for the employer’s convenience. If the employer requires the employee to maintain a home office as part of his or her job requirements, the use of the home office is also considered to be the employer’s convenience. As more people work at home and are not provided a space to work at their employer’s premises, it may be easier for employees to establish that it is being done for the employer’s convenience, say, to save the employer on the cost of providing workspace in the company’s office.”
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