Clarifying the Home Office Deduction for both Employees and Business Owners

We frequently get asked by clients about different rules surrounding the home office deduction as it seems more common that business owners and employees are finding that it makes more economical sense to work from home. The IRS recently released in Rev. Proc. 2013-13 a new optional Safe Harbor method to calculate the deduction for calculating the business use of home that may encourage those to take these deductions who have not taken it in the past. For those clients using the actual expense method to calculate the deduction we will clarify what information is important for you to provide to us and what is not; hopefully saving you some time in collecting your tax information to give to us when we prepare your tax return.

First it is important to understand what requirements need to be met to take a deduction for home office expense. The IRS states that a deduction is allowed for a portion of your home that is used exclusively for business on a regular basis as a principal place of business including in an administrative or management capacity or as a place for meeting or dealing with customers, clients or patients. There is an additional requirement for an employee to take a home office deduction in that the home office needs to be for the benefit of the employer not the employee.

For tax years beginning in 2013 taxpayers can elect to take a safe harbor deduction for the business use of their home. The election is made with the filing of the tax return and can change from year to year. This safe harbor deduction is calculated by taking the square footage of the office and multiplying it by $5 per square foot up to a maximum of 300 square feet. Since this is a safe harbor taxpayers cannot deduct any further expenses related to the business use of home, however they can deduct business expenses unrelated to the business use of home. The safe harbor method is subject to a gross income limitation in that the amount of the deduction computed cannot exceed the gross income derived from the business use of the home, less the business deductions unrelated to the qualified business use of a home.

Under the actual expense method the taxpayers determines the percent of their home used exclusively for business using a reasonable method. The most common method we use is the square foot approach in which the area used exclusively for business is divided by the total area of the house. The IRS describes home office expenses in three different categories, the first being a direct expense which is an expense that is used only in the business part of the home examples include painting or repairs of the area used only for business, these expenses are fully deductible. Indirect expenses are expenses for keeping up and running your entire home and they include insurance, utilities and general repairs and are deductible based on the percentage of your home used exclusively for business. Unrelated expenses are only for parts of your home not used for business such as lawn care and landscaping or painting a room not used for business, in this case no proportion of these expenses are deductible.

Both methods have their advantages and disadvantages depending on your situation. If your deduction for business use of home under the actual expense method does not meet or exceed the deduction you are entitled to under the safe harbor method then it would make sense to use the safe harbor method. Additionally the time spent to gather the expenses to use the actual method may not be worth it if you deduction will not be much higher than it would be under the safe harbor method, however you lose the ability create a loss through the home office deduction. With the actual expense method the time to compile the necessary expenses is more time consuming then it is under a safe harbor method, however with that burden comes the ability to have a higher home office deduction.

Commonwealth Financial Network does not provide legal or tax advice. Tax preparation and tax services offered by Summit Financial Strategies are separate and unrelated to Commonwealth Financial Network.

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