Simplified Home Office Deduction
For those who meet the requirements, the home
office deduction can be a tax-saver. Yet, the hassle of filing
out the 43-line form with its complex calculations to allocate expenses,
depreciation and carryovers of unused deductions is so daunting that
many people don't bother. In response to this complexity, the IRS
has provided a simplified method of claiming the deduction.
Can
You Claim a Home Office Deduction?
In order to use the simplified
method, you first must meet the qualification requirements for the
home office deduction. These are strict and you will be held to a
standard that an employee working in the employer's office is not
required to meet. There are three core conditions for
claiming any amount as a deduction:
- Exclusive use. Your home office must
be used exclusively for business purposes. There are limited exceptions
for day care providers and for inventory storage, but if those don't
apply, even the slightest bit of non-business use by you or anyone
else will cost you the right to the deduction.
- Regular use. Making use of the space
"every so often" will not satisfy this test.
- Business use. The space must be your
principal place of business or used for face-to-face meetings with
customers or clients on a regular basis. Principle place of business
doesn't necessarily mean the only place of business, provided there
is no other fixed location where you conduct substantial administrative
or management activities for your business.
What Is the Simplified Method?
For once, what the
IRS calls simplified actually lives up to its name at least in terms
of computing the deduction. To determine your home office deduction
under this method, you multiply the 'allowable square footage' for
your home office by 'the prescribed rate.'
The allowable square
footage is the lesser of:
- The actual square footage of your home office or
- 300 square feet.
The prescribed rate for 2014 is $5 per square foot. (The
IRS says it will update this rate from time-to-time when it feels
it is necessary to do so.)
The maximum deduction that can be
claimed using this method is $1,500. However, you can't claim more
than your gross income of your business that is attributable to the
business use of your home minus any business deductions that are unrelated
to the use of your home (such as business equipment and supplies).
And, any amount that is disallowed because of this income limitation
is lost it cannot be carried over to offset income in another tax
year.
You make the election to use the simplified method by
simply using it when you file your tax return. Bear in mind, once
you elect to use it (or not use it) you cannot change your mind for
that tax year. You can, however, elect to use whichever method you
wish on a year-by-year basis.
Should You Use the Simplified
Method?
As you probably learned the hard way while growing
up, just because you can do something, doesn't mean you should. In
this case, there are a number of situations where simple might not
be better. Although time is money, money is also money and you don't
want to hand Uncle Sam any more of yours than you legally must.
If
any of these apply to you, then you will want to check both options
for this year, and then be alert for changes that could affect your
decision is future years.
- You rent, rather than own particularly if you live in a high rent
area
- You pay a significant amount of mortgage interest or real property
taxes
- You have high utility costs attributable to the business use of
your home
- You have home office deduction carryovers from prior years
- You have very little income this tax year
- You didn't use your home for business for the full year
- You foresee switching between the two methods
Let's explore each of these in more detail.
You
rent, rather than own. The home office deduction
is often of greatest value to renters. The 'big ticket' deductions
that are rolled into the home office deduction are mortgage interest
and property taxes. A homeowner can claim these deductions regardless
of whether he or she claims a home office deduction the difference
is where and how they are claimed, not whether they are deductible.
But, a renter has no way to recoup rental costs, absent a home office
deduction. Therefore, if you rent, you will definitely want to do
a quick computation using the regular method and the simplified method.
This is especially true if you are living in a high-rent area, such
as New York, San Francisco, or Washington, D.C.
The home office
deduction is based on the percentage of space used for the home
office: All the expenses are allocated to the home office based on
this percentage. There are two standard
methods of computing this percentage: square foot and number of
rooms method. Using the square foot method, the square footage of
the space used regularly and exclusively for business is divided by
the total square footage of your home. Using the number of rooms
method, the number of rooms used for your home office is divided by
the total number of rooms in the home.
Many times one
of these methods will result in a much larger deduction. And, either
of them is likely to yield a larger deduction that the simplified
method.
Raymond uses one bedroom of his two bedroom Washington,
D.C., apartment as the principal office of his software development
business. The home office is 100 square feet. The total square footage
of his four-room apartment is 556 square feet. His monthly rent (which
includes utilities) is $1,800/month.
Using the regular square
foot method, he can deduct 18 percent of his rent (100/556). With
this method, his deduction is $324/month or $3,888 per year.
Using
the regular percent method, he can deduct 25 percent of his rent (1/4).
So, his monthly deduction would be $450/month or $5,400/year.
Either
of these methods would give Raymond a substantially higher deduction
than the $1,500 he could claim using the simplified method.
>
Your mortgage
and taxes are high. As noted above, homeowners can deduct
their mortgage interest and property taxes regardless of whether they
claim a home office deduction. However, without the home office deduction,
these are claimed on Schedule A as itemized deductions that offset
your adjusted gross income. In contrast, mortgage interest and taxes
claimed as part of the home office deduction is used to directly reduce
your income from your business. This, in turn, can lower your adjusted
gross income and increase your tax savings.
Lowering
your adjusted gross income can be an exceptionally important strategy
if you are near the threshold for the new 3.8 percent Medicare tax
on net investment income. Similarly, if you are bumping up against
the 0.9 percent Medicare surtax on earnings, lowering your net earnings
from your business can save you taxes on multiple fronts.
>
Your home-related
expenses are high. Some businesses involve increased
utility costs, such as the cost of specialty lighting. Some require
additional homeowner's insurance coverage. For example, if clients
regularly come to your home, you will probably want to increase your
insurance to protect you if they slip and fall on black ice on your
driveway. Other businesses may require you to make alterations to
the existing space, such as installing display cases or partitions.
If you use the regular method of determining the home office deduction,
some if not all of these increased costs can be deducted. You do not
have this option if you use the simplified method.
Your
business income is low. Regardless of the method used
simplified or regular your home office deduction for any year is capped
at the amount of your income from your home-based business. However,
if you use the regular method, you can carryover the amount that you
cannot use to subsequent tax years. If you use the simplified method,
you simply lose the value of the deduction. Also, if you used the
regular method to figure your deduction for business use of the home
in a prior year and your deduction was limited, you cannot deduct
the disallowed amount carried over from the prior year during a year
you figure your deduction using the simplified method. Instead, you
will continue to carry over the disallowed amount to the next year
that you use actual expenses to figure your deduction.
In 2014, Liz's net income from her fledgling home-based
craft business is $1,000. Using the simplified method, her maximum
home office deduction would be $1,400. Because she cannot claim more
than her income, $400 worth of deductible expenses are lost. If she
spends the time to struggle through the regular method, any amount
that she can't claim on her 2014 return can be carried over to offset
income in 2015 (assuming she opts for the regular method in 2015 as
well.)
>
You weren't in business all
year. If you used your home for business for only part of the year, you will have to prorate
your square footage, which will reduce your maximum deduction. In
order to count as a month of use, you must use your home office for
at least 15 days out of each month.
You foresee
switching methods. One of the blessings and curses
of the simplified method is that you do not have to worry about determining
the amount of depreciation on the business portion of the home. If
you use the simplified method, the amount of depreciation is defined
to be zero. This means that you not only avoid computing it, you
avoid having to recapture it when you sell your house.
If you use the regular method to compute the home
office deduction and you don't claim the appropriate amount of depreciation,
you will hurt yourself in both the short and long-term. Short-term,
you'll have a smaller annual deduction. Long-term, the IRS will demand
that you recapture the amount of depreciation that you should have
claimed.
>
As long as you keep using the simplified
method, the rule regarding depreciation will not cause you any grief.
If you have significant depreciable improvements to your property,
you may lose some tax benefits by not using the regular method, but
for most homeowners, that is not likely to be an issue. However,
if you switch between the methods, you (or most likely your accountant)
will have to deal with a series of recomputations, using special tables.
While this shouldn't be the sole determination for whether you opt
for the simplified method, it certainly is one consideration.
Choose
Wisely
There is no doubt that the simplified method will save
you time and aggravation. You need to carefully evaluate your circumstances
to see if it will also save you money.
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