Simplifying Home Office Deductions

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Office-626098_1920The IRS has now made it easier for small business owners to deduct home office expenses.  Beginning with 2013 tax returns, you can elect to use the simplified method allowing a maximum $1,500 deduction (IRS Internal Release 2013-5).

Don't automatically take the “easy way” out!  You should calculate the home office deduction using both the traditional choice and the simplified method.  In many cases, you will find the traditional method will result in a larger tax deduction.

To qualify for the home office deduction, you must use the office (1) regularly and exclusively as your principal place of business, or (2) as a place where you can meet or deal with customers, clients, or patients in the normal course of business, or (3) as the place where you conduct virtually all of your management and administrative activities.  If you’re an employee, you must use the home office for the conveniences of your employer.

This means that if you are self-employed and run your business from home, you will most likely be eligible to take the deduction.  However, if your main office is downtown and you merely take work home with you, then you probably won’t qualify.

Assuming you use the traditional method, you may write off the direct expenses for your home office (such as repairs and maintenance) plus a share of the indirect expenses like mortgage interest, property taxes, utilities, insurance, and repairs.  The amount of mortgage interest and property taxes not deducted as home office can be deducted as an itemized deduction on Schedule A.  You can also depreciate the part of the home used for business.

If you use the simplified method you can deduct mortgage interest and property taxes in full on Schedule A with no proration to the business.  But both methods are limited to the net income.  So if you have a loss, it will not help you in this year.  The traditional method allows you to carryover unused deductions while the simplified method does not.

The traditional method also requires that you keep detailed records documenting each item reported on Form 8829.  If you use the new simplified method, all you have to do is calculate the square footage of your home office and multiply it by $5, up to a maximum of $1,500 per year.

You may switch between methods from year to year based on which method results in a lower tax liability.  But the carryover of the prior year’s unused home office expenses cannot be used in years where you elect the simplified method.