Deducting legitimate expenses for a home office isn’t easy, but it can be done. Millions of taxpayers (including self-employed individuals and business owners) claim such deductions each year. Moreover, the process may be easier for 2013 and future years, thanks to an IRS ruling. In Revenue Procedure 2013-13, the IRS spelled out an optional method to report expenses for business use of your home. The process is simple, to say the least: you find the size of your home office and multiply the square footage by $5. Example: Sarah Williams keeps an office in her home. She measures the space at 225 square feet. Multiplying 225 by $5, Sarah calculates and claims a deduction of $1,125 on her 2013 income tax return. The IRS calls this a safe harbor method, meaning that Sarah doesn’t need to show $1,125 of expenses related to the business use of the home.
Assessing the advantages
Simplicity is the prime advantage of the safe harbor method. Under prior law, taxpayers had to fill out IRS Form 8829, which has more than 40 lines, in order to claim home office deductions. If you use the safe harbor method, you won’t have to deal with Form 8829. You can, if you wish, go back and forth between Form 8829 and the new safe harbor method, from one year to the next. What’s more, you also can deduct other expenses of your business that are not related to the business use of your home. Such deductions could include advertising and supplies, for example. In addition, if you itemize expenses on Schedule A of Form 1040, you can include all of your mortgage expenses, real estate taxes, and casualty losses. Taxpayers using Form 8829 must allocate such expenses between business and personal use.
Now for the negatives
Using the safe harbor method will be simpler but may not be better. Under the new rules, the home office deduction is limited to home offices of 300 square feet, for a maximum deduction of $1,500. That’s true even if your home office is larger. When you use this safe harbor deduction, you can’t take depreciation deductions for your home office. Altogether, it’s possible that your annual deductions will be less, if you use the safe harbor method, compared to the deductions you can claim by filling out Form 8829. Maximizing business expenses on Form 8829 may have secondary benefits, too. You’ll reduce your business income, which may decrease your self-employment tax obligation. You’ll also reduce your adjusted gross income, which may generate more tax deductions and tax credits elsewhere on your tax return.
Regardless of whether you use Form 8829 or the safe harbor method, you’ll have to pass certain tests to qualify for home office deductions. For example, the space in your home that’s used as an office must be used regularly and exclusively for business. After clearing this hurdle, a home office must be either the principal place of business; a place used by patients, clients, or customers in the normal course of business; or in a separate structure where business is conducted. If you’re an employee, you’ll be entitled to a home office deduction only if the office is for the convenience of your employer. In any case, your home office deduction can’t exceed the gross income from the related business. Our office can help you determine whether the safe harbor option is desirable for you.