Home Office Deduction
One of the most over looked deductions is the home office deduction. Many years ago when the home office deduction was placed into law it was a high audit target for the IRS because is it was abused and many taxpayer’s did not understand the requirements of the deduction and how to implement the deduction. That changed about twenty years ago with a series of court cases and IRS rulings that clarified the law and have offered significant guidance on how to apply the deduction.
Requirements
There are two basic requirements in order to take the home office deduction. First, you must have a designated office in your home. This must be a designated space or room that you use for work only. It can’t be a wall in your bedroom, your kitchen table, or workbench in your garage. It has to be a room that is specifically used for work or business. Second, the room must be used “regularly and exclusively” for work or business. Basically what this means is that you cannot have another office where you work and meet with clients on an exclusive basis. If you have a home office in which that is where you do all of your work and you no other office outside of your home in which you can do work or is available for you to do work then you are usually free and clear to take the home office deduction. The problem arises when you have more than one office and you work in both offices. In most of these situations you would not be allowed to take the home office deduction unless it was determined that you used the outside office sparingly and could prove that you used the home office on a regular and exclusive basis to see clients and to work from the home office location. Over the past few years the IRS has become more lenient in allowing the home office deduction for management and administration purposes even if there is another office that is used for other purposes.
Home Office Calculation
There are two generally accepted home office deduction methods for calculating the home office deduction. One method is the “square footage method”. With this method you divide the square footage of the home office into the square footage of the entire home. You then multiply that ratio by all of the expenses of the home which typically include mortgage interest, property taxes, insurance, repairs, utilities, association dues, rent and depreciation. Another accepted method is the “rooms method”. With this method, if there are rooms and they are approximately the same size, then you can divide the office into the number of rooms to determine ratio and multiply that ratio against all of the home expenses. Both of these methods should be evaluated to determine which deduction will provide the greater deduction.
Where to Deduct
The home office deduction can only be deducted on a individual income tax return. The taxpayer will use the form 8829 to make the deduction. On the form 8829 you will report what form that you want that deduction to flow to and be deducted. For most taxpayers the Schedule C (Sole Proprietor) is the form that is most commonly used in which the home office deduction will be applied. However, the home office deduction can also be applied to the Schedule E (Partnerships & Rentals) as well as the Schedule F (Farmers)
Safe Harbor Rule
Two years ago a new law was passed that allows for a simplified calculation in determining the home office deduction. This new law really simplifies the calculation by creating a safe harbor rule that allows the taxpayer to multiply the square footage of the office by $5.00 per square foot. This safe harbor deduction caps out at $1,500. To illustrate, if you have a 400 sf office and you decided to elect the safe harbor home office deduction the most you deduct would be limited to $1,500 even though the calculation would be $2,000( 400sf x $5.00 ). Because of this safe harbor rule there is no need for record keeping as you not keeping track of actual expenses. In addition, because you are not allocating actual expenses you do need to allocate any of your mortgage interest or property taxes to the home office. They would be fully deductible as a itemized deduction under the safe harbor rule. When deciding which would be the greater tax benefit it would be wise to calculate the actual expenses home office deduction versus the safe harbor and then compare which one gives the greater tax deduction.