The New Home Office Deduction: Do You Qualify?
More than half the 27.8 million small businesses in the U.S. are home-based, and many of them claim a home office deduction on their tax returns. Until now, the only way to calculate the amount of the deduction was to track all actual costs related to the home office space. This required hours of record-keeping and tax preparation.
All that’s about to change. The IRS announced a safe harbor method for figuring the home office deduction starting in 2013. It's expected to reduce the paperwork burden on small businesses by 1.6 million hours annually.
Safe Harbor Deduction
What amounts to a standard deduction for home offices is a new deduction of $5 per square foot of office space. No more than 300 square feet of such space can be taken into account, so the maximum home office deduction under this option is $1,500. The safe harbor method can be used whether you own or rent your home.
The safe harbor method replaces the deduction for actual costs, including depreciation, utilities and insurance related to the office space. However, even if you use the safe harbor method, you can still deduct:
- Home-office expenses that would otherwise be deductible, such as home mortgage interest and real property taxes
- Expenses unrelated to operating the office, such as advertising, supplies and wages
The square footage is based on average monthly usage of home office space. You must use an area at least 15 days in a month for it to count. For example, say you start to use 425 square feet of office space in your home on July 22 and continue to do so through the end of the year. Your square footage is 125 (300 maximum square feet of space for August through December ÷ 12); your deduction is $625 (125 x $5).
You can choose to use the safe harbor method one year and then deduct actual expenses the next. However, once you do use it for a particular year, you cannot change your mind later; the election is irrevocable.
Basic Home Office Tax Rules Still Apply
Whether deducting actual costs or the safe harbor amount, you can only take a deduction if you qualify for a home office write-off. This means you must use the space in your home regularly and exclusively for business (with special rules for daycare businesses) and meet one of the following tests:
- Your home office is your principal place of business (i.e., you have no other fixed location for your business activities).
- You regularly use a portion of your home to meet and deal with customers, clients and patients in the normal course of your business even though you have another spot for your principal place of business.
- You use a freestanding structure, such as a studio, workshop, garage or barn, regularly and exclusively for business even though this structure is not your principal place of business or a place to meet or deal with customers, clients or patients.
Also, as in the case of actual expenses, the safe harbor deduction cannot exceed gross income from the home office activity. In other words, if you have an overall loss for the year, no deduction is allowed. What’s more, no carryover of the unused safe harbor amount (in whole or in part) can be carried over to a future year; it is lost forever. (This is different from an unused deduction for actual expenses, which can be carried forward indefinitely and claimed in future years). If you use the safe harbor method, you cannot add to it any carried over amount from a year in which you deducted actual expenses.
The safe harbor deduction cannot be used by an employee who receives reimbursement from his or her employer for home office expenses.
If you're a homeowner, then any year you want to use the actual expense method after having deducted the safe harbor amount means you’ll have to figure depreciation using an optional depreciation table.
The notion of a standard deduction for a home office first began in 2009, so it took four years to crystallize. And these rules are not 100 percent certain yet. Even though they're set to begin for 2013, the IRS has requested comments from tax professionals and small-business owners on the rules. Things could change, so stay tuned!
Barbara Weltman is an attorney; author of J.K. Lasser’s Small Business Taxes and The Complete Idiot’s Guide to Starting a Home-Based Business; and host of Build Your Business radio. Follow her on Twitter @BarbaraWeltman.