Individuals who maintain home offices will have an alternative method for computing their home office income-tax deductions for the 2013 tax year and beyond. The IRS has announced a new “safe harbor” deduction that is easy to calculate — and can help avoid the record-keeping headaches normally associated with deducting home office expenses.
BackgroundIn general, federal tax law prohibits a deduction for the business use of a dwelling that is also used by the taxpayer as a residence during the year. However, exceptions apply.
An individual may claim deductions for direct expenses and the business-use portion of indirect expenses relating to a home office if:
- Part of the home is used regularly and exclusively as (1) a principal place of business or (2) a place to meet or deal with customers or clients in the ordinary course of business.
- In the case of an employee, the use of the home office is also for the convenience of the employer.
These home office deductions are limited to the business activity’s gross income reduced by all other deductible expenses that are allowable regardless of business use (examples: mortgage interest, real estate taxes) and by business deductions that are not allocable to the home itself (examples: supplies, advertising expenses). Excess home office expenses can be carried forward to later tax years.
Currently, an individual must file a 43-line form (IRS Form 8829) to claim a home office deduction.
The New RuleFor tax years starting in 2013 (that is, for tax returns filed in 2014 and later), an individual maintaining a home office may use an optional safe harbor method for computing the home office deduction.
With this method, the taxpayer may determine the deduction for qualified business use of the home by multiplying a specified rate ($5 for 2013) by the number of square footage in the home used for business purposes, not to exceed 300 square feet. Therefore, the maximum deduction under the safe harbor method will be $1,500. The $5 rate may be updated by the IRS from time to time, as warranted.
Example: Jackie uses a 500-square-foot area in her basement exclusively as the principal place of business for her beauty salon. If Jackie elects to claim her home office deduction using the safe harbor method, she can only claim a deduction of $1,500 ($5 times 300, the maximum square footage allowed).
This safe harbor method is an alternative to deducting the actual expenses of maintaining a home office.
Generally, a taxpayer using the safe harbor cannot deduct any actual expenses related to the qualifying business use of the home for that year. Exceptions apply for:
- Otherwise allowable residence-related deductions such as mortgage interest and property taxes (as long as the taxpayer itemizes deductions) and
- Non-home office business expenses.
An individual may elect each year whether to deduct actual home office expenses or use the safe harbor method.
Caution Is RequiredOne important thing to keep in mind is that for many individuals, the safe harbor method will result in a smaller home office expense deduction than using the actual expense method. While the recordkeeping and reporting requirements are tougher, the actual expense method could result in a much higher deduction.
Moreover, if you are self-employed, a larger home office deduction could reduce your income for self-employment tax purposes as well as income-tax purposes. As a result, we recommend computing the deduction using both the actual expense method and the optional safe harbor method (starting with 2013’s return) to see which provides the larger tax benefit.
For more information, contact Doeren Mayhew’s dedicated Tax Group, with CPAs in Troy, Mich., and Houston, Texas.