The Home Office Tax Deduction – Is It For You?

Let’s get things straight about home office deductions.

In this day and age, many individuals are starting and operating their own small businesses out of their homes and apartments. Against a backdrop of cost cutting and footprint reduction by Corporate America, many employees are required to maintain home offices in order to accommodate flexible work schedules and telecommuting. Per Code Section 280A(c)(5), those who use part of their residence to conduct business have the ability to take a tax deduction for associated expenses incurred for the exclusive business use of their home. These expenses are reported on Form 8829 – Expenses for Business Use of Your Home.

There are a few requirements you have to adhere to in order to qualify for this deduction. First and foremost, the home office must be used regularly for conducting business exclusively. For example, if you converted one of your bedrooms into an office that is used exclusively for business, all of the facets of that room must be used for business purposes. For example, if there is a closet in the room, that closet must also be used for business purposes.

Your home office must also be one of your primary business locations. The code states that your home office does not have to be your only business location, only that it has to be one of your primary business locations. For example, you may have a deduction for a home office in addition to an independent office that you rent.

To further qualify for tax reimbursement, your employer must require that you maintain a home office in order for you to perform your duties as an employee of

their company. Furthermore, your employer may not be reimbursing you for any expenses incurred in using part of your home as a home office, whether in the form of rent or expense reimbursement.

There are two methods of calculating home office deductions: the regular method and the simplified ‘Safe Harbor’ method.

The regular method of claiming the home office deduction requires that you to come up with a list of expenses incurred in maintaining your home. These expenses must be supported by financial records. A portion of these expenses can be determined by calculating the square footage of your home office vs. the total living square footage of your home. For example, if it costs you $10,000 to maintain your home, and the square footage of your home office is 10% of the total living area of your home, then you may deduct $1,000 as a home office deduction. The costs of maintaining your home includes, but is not limited to, mortgage interest, insurance, taxes, repairs, utilities and other expenses.

As a side note, any depreciation taken as a deduction reduces the cost basis of your home. While this might not matter on a day to day basis, it might affect you when you sell your home. The deduction, as computed under the regular method, also has gross and net income limitations, and excess deductions not taken may be carried forward to future years.

As you can see, claiming the home office deduction involves quite a bit of work: gathering the financial documents, computing the total expenses for each category, calculating the square footage of your home office vs. your home. As a remedy, the IRS introduced the ‘Simplified Safe Harbor method’ in 2013 pursuant to Revenue Procedure 2013-13. The goal of this method is to simplify the calculation of the home office deduction and also to streamline the documentation requirements related thereto. Using a prescribed rate of $5, taxpayers can compute their home office deduction by using the set rate and applying it to the allowable square footage of your home office (up to 300 square feet). For example, the maximum home office deduction using this method is $5 x 300 or $1,500. By using this method, taxpayers are released from the documentation requirements of the regular method. It is important to note that this deduction cannot exceed the net profit of the business, and cannot be carried forward. You may also not deduce depreciation.

Once you determine the best method to compute your home office deduction, you may use your selected method on your timely filed, original federal income tax return for that tax year. Once you have used either method, you may not make a change for that same tax year. You may change methods from year to year, however.

A special allocation rule exists for home based daycare businesses that do not exclusively use a specific area of the home for business purposes. In this case, the Internal Revenue Service allows you to use the total number of business hours to allocate and compute a home office deduction.

Contact us for further details on how to claim this deduction. As more and more people start their own small business, and as Corporate America keeps cutting costs and reducing their footprint, this deduction will be used more and more often. We can help you sort through the complex Internal Revenue Code and apply the best deduction for you.

Posted by Terranova & Associates LLC

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