Beginning with tax year 2013, the IRS is offering a Simplified Method for deducting expenses related to business use of your home. This is a welcome change since this deduction has confused so many taxpayers. Most of us don’t know whether our home office qualifies, or, if it does, how to take the deduction.
What Qualifies as a Home Office?
There are four basic tests that determine whether your home office is a qualifying home office.
- Exclusive Use – You must use this part of your home exclusively for business. If you have a home office that you sometimes use for your business, its expenses are not deductible.[i]
- Regular Use – The business use of this part of your home must be regular. It cannot be occasional or infrequent.
- Trade or Business Use – This part of your home must be used in connection with a trade or business.
- Principal Place of Business – This part of your home must be your principal place of business. A home office is automatically considered the principal place of business if there is no other work location, if there is no other work location for administrative duties, if it is a location for meeting clients or if the home office is a separate structure such as a garage or studio.
How do I deduct Home Office Expenses?
There are now two methods for taking the tax deduction and taxpayer’s can choose, each year, which one they will use.
- Standard Method – Under the standard method a taxpayer deducts a percentage of certain household expenses. The deductible percentage is based on the square footage of the part of the home used for business as compared to the total square footage of the home. These expenses are calculated and reported on Form 8829.
- New Simplified Method – Beginning with 2013, taxpayers can forgo all the calculations and just take $5 per square foot of the home used for business.[ii]
What expenses are deductible using the Standard Method?
Expenses are divided into “direct” and “indirect” expenses. Direct expenses are those that only benefit the part of the home used for business and indirect expenses are those that relate to the entire home. For example, painting the home office would be a direct expense while utilities would be an indirect expense. Here’s a list of the most common home office deductions:
- Mortgage Interest and Taxes if home is owned
- Rent if home is rented
Which method should I use?
In most cases, a home owner will want to use the Simplified Method while a renter could go either way depending on the size of the home office.
For a home owner, the Simplified Method has an added bonus. The $5 per square foot is designed to give the taxpayer a deduction similar to what they would come up with if they used the Standard Method. If using the Standard Method, a home owner would include their mortgage interest and real estate taxes to calculate that deduction. If the Simplified Method is used, a taxpayer may come up with a similar deduction (to what would be calculated using Standard Method) AND still be able deduct their mortgage interest and real estate taxes as an itemized deduction on Schedule A. This allows for double dipping of deductions for the home owner. A renter does not receive the same benefit. Unlike mortgage interest and real estate taxes, rent is not otherwise deductible.
As always, there are other factors to consider in choosing which method to use and each taxpayer’s situation is different.[iii] The important thing is, if you just don’t want to deal with it, all you have to do now is take the square footage by $5 and you have your deduction. Easy as pie.
[i] There are two exceptions to this test. The expenses can still be taken if this part of your home is used to store inventory or if you use part of your home as a childcare facility.
[ii] There is a maximum deduction of $1,500 (300 square ft.)
[iii] The Simplified Method also has an effect on depreciation and carry-overs.