To take the deduction, the IRS requires the home office to be your principal place of business and it must be used exclusively and on a regular basis. According to the Small Business Administration, just over half of the country’s 28-million small businesses are based in a home, but only 3.4-million taxpayers claimed this deduction. The most common reason for not taking the deduction is the complexity of the paperwork (i.e., IRS Form 8829) taxpayers must file. A second reason for not taking the deduction is fear of an IRS audit, which may also be attributed to the form’s complexity.
Effective for year 2013 and later, a new simplified, “safe-harbor” method of calculating your home-office deduction is available. Simply, you are allowed to deduct a flat $5 per square foot of dedicated office space in your home, up to a maximum of 300 square feet; thus yielding a $1,500 maximum deduction. Under this alternative, a taxpayer can forego all the information-gathering and avoid the 43-line tax form previously required.
The second and established method for a home-office deduction uses Form 8829, whereby taxpayers must determine which costs are “direct” or “indirect” expenses. Direct expenses let you write off 100 percent of costs associated specifically with your home office, everything from painting the office to buying a work computer, or a second phone for the home-based business. “Indirect” expenses are pro-rated, based on the size of your home office. These are things like your property insurance, mortgage, utility bills and a home-alarm system. If the square footage of your home office equals 10 percent of your home’s, you can claim 10-percent of these expenses. Additionally, one must compute depreciation for the home-office portion. Good luck with that one.
You may choose either the simplified method or the actual expense method for any year. Once you use a method for a specific tax year, you cannot later change to the other method for that same year. Each home-office deduction method has its benefits:
• Very simple computation: $5 multiplied by home office square feet. Maximum write-off is $1,500.
• Eliminates the need to fill out 43 lines of Form 8829, saving hours of work for taxpayers.
• No receipts for insurance, utilities, repairs and maintenance; a lot of recordkeeping and computation avoided.
• “Safe-harbor” method may be better for people who have paid off the mortgage or who have low property taxes.
• No depreciation deduction is allowed nor is a later recapture needed.
• Taxpayers with offices larger than 300 square feet will receive a larger tax deduction using actual expenses.
• If your actual expenses are higher, then it would make sense to use them to determine the deduction.
• Unused expenses (i.e., losses) not used for the current year can be carried over to the next year; the simplified method does not allow.
• No maximum annual deduction; you can exceed $1,500.
For most taxpayers, it is recommended preparing the home-office deduction for 2017 using both the new optional method and the traditional method and then choose the one that provides the maximum deduction. Regardless of which method you choose in 2017, you still have the option in subsequent years to choose which method benefits you the most.
Barry Lisak is an IRS Enrolled Agent, meaning that he has passed special U.S. Treasury Department exams that qualify him to represent clients dealing with audits or tax-resolution cases. Any questions can be directed to him at (516) TAX-SAVE, or firstname.lastname@example.org.