New “Simplified” Option for Deducting Home Office Expenses

Certain home office deductions are permitted for businesses run out of an individual’s home.  However, to be eligible for home office deductions, two basic requirements must be met:

1.     Regular and Exclusive Use:  You must regularly use part of your home exclusively for conducting business.  This test can be difficult to meet if the business part of your home isn’t separated from the personal part of your home such as by a door or by a separate structure.

2.     Principal Place of Your Business:  If business is conducted outside of your home, you can still qualify if you can show that you also use your home substantially and regularly to conduct business.  For example, you might have in-person meetings with clients or customers in the home.

The business home office deduction cannot exceed gross business income less other business expenses.  Any excess home office deduction can be carried over to the next year.

If you are not the business owner, but are an employee, then in addition to the above two tests, you must also meet the following two tests:

3.     Your business use must be for the convenience of your employer.  If the use of the home office is merely appropriate and helpful, you cannot deduct expenses for the business use of your home.

4.     You may not rent any part of your home to your employer and use the rented portion as the employee.

Starting with 2013 tax returns a new simplified option is available.  Instead of keeping track of actual expenses and prorating by the percentage of the square feet of your home used for business, a flat rate prescribed by the IRS multiplied by the business square footage can be used.  The simplified option does not change the above rules for qualifying for the home office deduction.  Rather, the method is like a standard deduction:  a $5.00 rate times up to 300 square feet (roughly 17 by 17 feet), or $1,500 is permitted.  You can choose each year to use either the regular or the simplified method.  Once selected, the method cannot be changed for that tax year.

Benefits of the simplified option include:

1.     Mortgage interest and real estate taxes can be deducted in full as itemized deductions.  They are not considered part of the $5.00 rate.

2.     The $5.00 rate is not considered to include home depreciation (and none may be claimed under the simplified option), so there is no depreciation recapture if you later sell your home.

3.     The $5.00 rate does not reduce other business deductions that are unrelated to the home.

Disadvantages of the simplified option include:

1.     The business square footage is limited to 300 square feet.

2.     Any excess home office deduction above business net income may not be carried over to the next tax year.

3.     No home depreciation deduction can be claimed.  If actual expenses are used in a later year, depreciation is computed using the optional depreciation table as if there had been no interruption in depreciation years.

4.     A carryover of unused home office deduction from an earlier tax year may not be claimed.

Despite the limitations imposed on the simplified option, some taxpayers may benefit from it.  More information can be obtained by referring to RevenueProcedure 2013-13, IRS Publication 587, or Form 8829.