The structure of the traditional job market has shifted drastically in recent years and as more Americans are working from home, it’s important that they are correctly and accurately claiming home office tax deductions.
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According to a survey conducted by the U.S. Census Bureau, the number of people who worked at home at least one day per week increased to 13.4 million in 2010 from 9.5 million in 1999, increasing to 9.5% of all workers, yet the IRS reports only 3.4 million claimed deductions for business use of a home in 2010.
Claiming home office deductions can be intimidating, but many eligible business owners are leaving money on the table out of doubt and fear of auditing, says tax consultant Margaret Munro.
“The home office deduction is one of the most misunderstood and abused deductions out there,” she says. “If you have a valid home office, you take the deduction because you shouldn’t be paying tax on money that you’re using for your business.”
To simplify the process, the IRS has announced a new safe harbor provision for taking home office deductions for the 2013 tax year. This allows at-home workers the option to simply take a deduction capped at $1,500 per year based on $5 a square foot for up to 300 square feet.
The requirement that home office space be exclusively used for business and limitations on income earned from that business still applies, and direct business expenses unrelated to the home (advertising, supplies and wages paid to employees, etc.) are fully deductible.
Benefits of Safe Harbor Provision
By eliminating the need to fill out all 43 lines of Form 8829, the IRS estimates that more than 3.4 million taxpayers who claim the optional deduction will save at least 1.6 million hours of recordkeeping annually.
“Rather than keeping receipts for insurance, utilities, repairs and maintenance, taxpayers will be able to simply claim a deduction of $5 per square foot of their home office as their deduction,” says Dara Spivack, assistant professor in the College of Business at Bellevue University.
Despite the fact that homeowners using the new option cannot depreciate the part of the home used in a trade or business, taxpayers who itemize their deductions can still claim their mortgage interest, real estate taxes and any casualty losses on their home on Schedule A, notes Mary Kay Foss, CPA at Sweeney Kovar, LLP.
“When you sell your house, you have to pay back that depreciation that you took [with the old method] and it’s taxed at 25%,” she says. “Some people are reluctant to even do the office at home because of that depreciation thing hanging over their heads and with this new provision, there is no depreciation component to it so you can throw that concern away,” she says.
Which Method Makes More Sense?
Since the simplified method for claiming expenses for the business use of a home office is optional, taxpayers can change their filing method from year to year.
“People who have paid off their mortgages or who have low taxes or are just using a miniscule piece of their property may well be better off using the safe harbor method than the old, itemize it all out method,” says Munro.
Spivack recommends taxpayers with offices larger than 300 square feet look carefully at how $1,500 compares with deductions they have claimed in prior years.
“If your actual expenses are higher, then it would make sense to use those to determine the deduction,” she says. “This might especially be important for taxpayers who cannot itemize their deductions and thus would lose any deduction for mortgage interest and real property taxes.”
It’s important to note that business owners using the regular method to determine their deduction can carry any unused expenses over to the next year, but those who use the simplified method may not.
“Let’s say that your office in home deduction comes out to only $1,300 but you don’t have a profit that year, that $1,300 will carry forward to the next year and in that next year if you have a profit, you’ll be able to deduct the current office in home plus the prior year office in home,” says Foss. “If you’re using this new method, there’s no carryover so there’s a calculation and if you don’t have a profit that year, you just don’t get it.”
Especially for the first year of the optional safe harbor provision, taxpayers who have been keeping records to support their home office deduction may want to continue to do so in order to ensure they can claim the largest deduction possible, recommends Spivack.
“The IRS has stated that the rules found in IRS Rev Proc. 2013-13 will definitely stand for tax year 2013 but may change in the future.”