Should You Take The New 2013 Simplified Home Office Deduction?

Ashlea Ebeling for Forbes writes: The Internal Revenue Service is touting the new “no-doc” $1,500 home office deduction that’s available for the first time this tax filing season, but don’t fall for it without doing your homework. “Remember, the IRS doesn’t necessarily do anything good for taxpayers unless it also benefits them,” says Cynthia Jeanguenat, an enrolled agent in Virginia Beach, Va. She didn’t alert her clients to the simplified deduction ahead of tax filing season “lest they stop keeping track of their expenses as we train them to do,” she says. “Is it easier? Sure. Is the deduction better? Not that I’ve found,” she adds.

Basically, the simplified method is an alternative to calculating and substantiating your actual expenses. It’s like using the standard mileage rate for deducting business auto expenses instead of the more cumbersome actual expenses (maintenance, gas, insurance). It may not be the best deduction but if you don’t keep records, it’s all you can claim.
To snag the home office deduction using the simplified method, all you have to do is multiply the square footage of your home office space (that’s space used exclusively and regularly for your home-based business) by $5, and that’s what’s deductible. The biggest catch: there’s a $1,500 maximum limit to the deduction you can claim this way.

By contrast, under the actual expenses method, you add up your rent or mortgage interest, renters’ or homeowners’ insurance, real estate taxes and utilities, and multiply that times the percentage of your house allocable to your home office. You can also deduct an allocable portion of general house repairs (say a new hot water heater) but that’s trickier. With either method, you can only reduce your business income to zero; you can’t take a loss.

Note: if you use the simplified method with the $1,500 cap, you separately get to deduct your mortgage interest and real estate taxes on Schedule A–assuming you itemize. Also with the home office deduction, you can switch from using one method one year to the other method another year.

The bigger your home office, the more likely the actual expense method will yield a bigger tax break. For example, Jeanguenat has three clients, a hair stylist, a contractor and a Shaklee rep who all have large areas of their homes devoted towards their home businesses and have been taking deductions for well over the $1,500 max under the simplified method. The hairstylist who converted her garage to a salon took a home office deduction of $4,881 last year.

By contrast, for a consultant client who claims just 5% of his total house square footage as home office space, his actual expenses for his home office come in close to the $1,500 max. But even if it’s over just a bit, why not claim it? “Clients are paying us to make sure they’re paying the lowest amount of taxes required,” Jeanguenat says. Most people who are in business are so used to having to keep receipts and all this information anyway, and with the ability to track expenses online it’s less burdensome than in the past. (Jeanguenat’s one-room home office came in at $1,701 last year so she expects to take the actual expense method again this year.)

Might you use the simplified method even if it results in a lower deduction? “If someone said, ‘I don’t have time to get my expenses together,’ at least now we have an alternative,” she says.

Who else might go for the simplified method? Folks with tiny home offices. Richard Rhodes, an enrolled agent who works out of a 127-square-foot office converted from a spare bedroom in his Hinckley, Ohio home made the calculations for himself and said he’ll be using the new simplified method. “I’m more than doubling what I would have gotten,” he says. He figures he’ll get a $635 ($5 x 127) deduction versus $302.

“You have to figure it out both ways and choose the one that save the taxpayer the most money on their taxes,” he says. So much for simplification.

For all the details, see IRS Publication 587, Business Use Of Your Home, which has been updated to include information on the simplified method for calculating the deduction. The IRS Revenue Ruling with examples is available here.