Key Choice on Home Office Deductions

Business Management Daily writes: The IRS has 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)

Strategy: Don’t automatically take the “easy way.” Figure out if you’ll come out ahead with the traditional approach for deducting home office expenses.

In many cases, you’ll find the traditional method will produce a significantly larger deduction.

Here’s the whole story: To qualify for home office deductions, you must use the office regularly and exclusively as your principal place of business (i.e., the place where you conduct most of your income-earning activities), or as a place where you meet or deal with customers, clients or patients in the normal course of business, or as the place where you conduct virtually all of your management and administrative activities. Also, if you’re an employee, you must use the home office for the convenience of your employer.

For instance, if you’re self-employed and you run your business from the comfort of home, you may be entitled to deductions. However, if your main office is downtown and you merely take work home with you, you probably won’t qualify.       

Assuming you use the traditional method, you may write off the direct expenses of your home office (such as maintenance and repairs) plus a proportionate share of indirect expenses like mortgage interest, property taxes, utilities, repairs and insurance. (Of course, mortgage interest and property taxes are deductible anyway.) In addition, you can claim a depreciation deduction for the part of the home used as an office.

However, the traditional method requires you to keep detailed records of expenses. Then you have to work through the 43 lines of Form 8829, Expenses for Business Use of Your Home, when you file your return.  

Conversely, if you use the new simplified method, all you have to do is calculate the square footage of your office space and deduct $5 per square foot, up to a maximum of $1,500.

When you add up all your deductible home office expenses, the total will often exceed the $1,500 maximum amount allowed by the simplified method.

Example: You’re self-employed and your home is the principal place of your business. The home is 3,000 square feet and you use a room of 300 square feet, or 10% of the home, as your home office.

Assume that you have $1,200 in direct ex­­penses for your home office plus your indirect expenses for the whole home—including utilities, insurance and HOA fees—amount to $10,000 for the year. (For this purpose, we’ll disregard mortgage interest and property taxes that would otherwise be deductible.) In addition, based on the IRS table, you may claim a $350 depreciation allowance.

As a result, you’re entitled to deduct $1,200 in direct expenses, $1,000 in indirect expenses (10% of $10,000) plus $350 in depreciation, for a total of $2,550. That’s $1,050 more than you could claim with the simplified method ($2,550 – $1,500).  

Tip: You may switch between the traditional and simplified methods year-to-year.

Create more tax room to maneuver

The percentage of business use of your home is generally based on the square footage calculated on Lines 1-3 of Form 8829.

Strategy: The IRS says you can use any “reasonable” alternative. Some taxpayers might claim deductions based on the number of rooms in the home if the rooms are of comparable size.

For example, say you use 10% of the home’s square footage as an office, but it’s one of eight rooms. In that case, the “rooms method” produces a bigger deduction based on 12.5% business use.