Posted by: Robert O'Neil, CPA
Starting with the 2013 tax year, the IRS is allowing a second, more simplified way of calculating the business use of a home deduction.
The business use of a home deduction allows a taxpayer to deduct a portion of the expenses they incur in connection with the use of their home in their business. These expenses include, among others, real estate taxes, interest, utilities, and repairs that relate to the home office. A taxpayer can also deduct space in the house that is used for the storage of inventory or if it is used to operate a daycare. Once your total business use of home deduction is calculated, it is subject to the business income limitation. However, any deduction in excess of the limitation is permitted to be carried forward.
The method of computing the deduction that has been allowed in the past and will continue to be permitted going forward is the actual expense method. Under this method, the expenses that are deductible are divided into two classifications, direct and indirect. The direct expenses relate solely to the home office, such as repairs to the office, for example. The indirect expenses encompass many of the other expenses related to the home, such as utilities, taxes, and insurance.
While the direct expenses are fully deductible, the indirect expenses are only allowed up to the percentage of square footage used in the business. Any mortgage interest and taxes above this percentage are still deductible as itemized deductions. The sum of the direct and indirect expenses results in the total deduction, which is subject to the business income limitation.
So, what’s changed?
As mentioned earlier, the IRS has introduced a simplified, safe harbor method of calculating the allowable home office deduction. Be cautioned, however, that the new safe harbor method, while easier to calculate, could result in lost deductions. Under the safe harbor method, a taxpayer is allowed to take a $5 per square foot deduction for the home office, up to a maximum 300 square feet. This results in a maximum deduction of $1,500 and allows the taxpayer to fully deduct their mortgage interest and property taxes on their schedule A.
However, the safe harbor method does have a downside; in the potential for lost deductions. Since the taxpayer elects to take a flat rate deduction, any expenses in addition to taxes and interest that could have been included are not permitted. The safe harbor method is also subject to the business income limitation and any excess is not permitted to be carried forward. Depreciation of the business portion of the home is also disallowed under the new method.
Looking at the upside, the business use of the home deduction can still be calculated using either method, which can result in maximizing their benefit. Additionally, the taxpayer can switch methods each year, so, if their expenses go above the safe harbor, they can elect the actual expense method to take advantage of the higher deduction.
For questions on this or any other tax related issues, please contact one of the tax professionals at Zinner & Co.
