What you should know about the home-office deduction

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 S.B.A., just over half of the country’s small businesses are based in a home, but only a small number of 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.

But there is a simplified, “safe-harbor” method of calculating your home-office deduction 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 forgo all the information-gathering and avoid the multi-line tax form previously required.

The second and established method for a home-office deduction uses IRS 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 home-alarm system. If the square footage of your home office equals 10 percent of your home, 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.

Simplified Method:

• Very simple computation; $5 multiplied by home office square feet. Maximum write-off is $1,500.

• Eliminates the need to fill out the complex Form 8829, saving hours of work for taxpayers.

• No receipts for insurance, utilities, repairs and maintenance; a lot of recordkeeping and computation avoided.

This “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.

Actual Expenses Method:

• 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 current year can be carried over to the next year; simplified method does not allow.

• No maximum annual deduction; you can exceed $1,500.

It’s recommended that most taxpayers prepare the home-office deduction using both the new optional method and the traditional method and then choosing the one that provides the maximum deduction. Regardless of which method you pick, you have ability in subsequent years to choose whichever method benefits you the most.

Barry Lisak is an IRS enrolled agent specializing in personal and small business taxes for 30 years. Any questions can be directed to him at 516-829-7283, or mrbarrytax@aol.com.