IRS eases the Home Office Deduction Computation
THE STATUTORY REQUIREMENTS
For purposes of (1) above, the term “principal place of
business” includes a place of business that the taxpayer uses for the
administrative or management activities of the taxpayer’s trade or business if
there is no other fixed location for the trade or business where the taxpayer
conducts the substantial administrative or management activities (Sec.
280A(c)(1), flush language).
There are also special rules for use of a portion of the home as storage space or to provide child care facilities, which are not addressed in this article.
EXCLUSIVE USE ON A REGULAR BASIS
According to the IRS, to qualify for the “exclusive use” test, taxpayers must use a specific area of their home exclusively for their trade or business, but the area does not need to be set off by a permanent partition. However, it must be used for the trade or business exclusively and at all times (not just during business hours), and any use of the space for nonbusiness purposes disqualifies the area, e.g., an office that is also used as a family room will not qualify. To qualify for regular use, the specific area of the home must be used on a regular basis; occasional or incidental use will not qualify. This determination is made based on all the facts and circumstances (see Publication 587, Business Use of Your Home (Including Use by Daycare Providers)).
WORK AT HOME IS FOR THE EMPLOYER'S CONVENIENCE, NOT THE EMPLOYEE'S
Many employees who work in their homes will not qualify for the deduction because they do it for their own convenience, not their employer’s.
It is not impossible to establish that the home office is for the employer’s, not the employee’s, convenience, but it is difficult.
If the use of the home office is necessary to allow the employee to perform his or her duties as an employee properly, or the use of the home office is necessary for the functioning of the employer’s business, it will be considered to be for the employer’s convenience. If the employer requires the employee to maintain a home office as part of his or her job requirements, the use of the home office is also considered to be the employer's convenience. As more people work at home and are not provided a space to work at their employer’s premises, it may be easier for employees to establish that it is being done for the employer’s convenience, say, to save the employer on the cost of providing workspace in the company’s office.
CALCULATING THE AMOUNT OF THE DEDUCTION
Calculating the home office deduction can be done one of two ways: the actual-expense method, under which the home office deduction amount is based on the actual expenses related to the use of the home office incurred by the taxpayer, or the new safe-harbor method, under which the deduction amount is determined by a formula based on the square footage used as a home office.
Whichever method is used to calculate the deduction, the amount of the deduction is subject to a gross income limitation, which, as discussed below, is calculated differently for each method. In addition, the carryforward rules for the deduction are different under each method. Under the actual-expense method, any excess of otherwise deductible expenses over the gross income limitation can be carried forward to the next tax year, subject to the same limitation (Sec. 280A(c)(5)). If the safe-harbor method is used, the amount of otherwise deductible expenses in excess of the limitation cannot be carried forward to future tax years.
ACTUAL-EXPENSE METHOD
Under the actual-expense method, taxpayers first must determine the percentage of their home that is used for business. This can be done by any reasonable method, but the most common approaches are either (1) the square-footage approach, in which the area used for business is divided by the house’s total square feet, or, (2) if the rooms in the home are all of a similar size, determining the percentage by dividing the number of rooms used for business by the total number of rooms in the house. For example, using the first method, a taxpayer whose office is 12 feet by 15 feet and whose house is 2,000 square feet uses 9% of the house in the trade or business.
After determining the percentage of the home expenses that the taxpayer can deduct as expenses for the business use of his or her home, the next step is to determine whether the deduction is subject to the gross income limitation. The deduction of otherwise nondeductible home expenses, such as insurance, utilities, and depreciation (with depreciation taken last), that are allocable to the business, is limited to the gross income from the business use of the taxpayer’s home, less:
The calculation of a taxpayer’s business use percentage and allowable deduction amount are performed on Form 8829, Expenses for Business Use of Your Home, for Schedule C filers, or on the “Worksheet to Figure the Deduction for Business Use of Your Home” in Publication 587 for employees and others.
THE NEW SAFE HARBOR
In January, the IRS released Rev. Proc. 2013-13, which gives taxpayers an optional safe-harbor method to calculate the amount of the deduction for expenses for business use of a residence beginning with the current tax year, 2013, for returns filed in 2014.
Individual taxpayers who elect this method can deduct an amount determined by multiplying the allowable square footage by $5. The allowable square footage is the portion of the house used in a qualified business use, but not to exceed 300 square feet. Therefore, the maximum a taxpayer can deduct annually under the safe harbor is $1,500. The IRS may update the $5 allowance from time to time, but it is not inflation adjusted. Because the up-to-$1,500 amount is a safe harbor, taxpayers who use the safe harbor cannot also deduct actual expenses related to qualified business use of the home for that year; however, business expenses that are unrelated to the use of the home (such as advertising) can be deducted.
To use the safe-harbor method, taxpayers must continue to satisfy all the other requirements for a home office deduction, including the requirement that the space in the residence used as an office be used exclusively for that purpose and the limitation that an employee qualifies for the home office deduction only if the office is for the convenience of the taxpayer’s employer. The safe harbor is elected on a timely filed original tax return, and taxpayers are allowed to change their treatment from year to year. However, the election for any tax year is irrevocable.
No depreciation is allowed for the years in which the safe harbor is elected. This may make this method more attractive for taxpayers who do not plan to stay in their homes a long time because they will then avoid the depreciation recapture that is required of taxpayers who took depreciation on their personal residences.
A taxpayer who itemizes deductions and uses the safe harbor for a tax year may deduct, to the extent allowable, any expense related to the home that is deductible without regard to whether there is a qualified business use of the home for that tax year (e.g., deductions for qualified residence interest, property taxes, and casualty losses). Taxpayers using the safe harbor deduct these expenses as itemized deductions on Form 1040, Schedule A, and cannot deduct any portion of these expenses from the gross income derived from the qualified business use of the home, either for purposes of determining the net income derived from the business or for purposes of determining the gross income limitation discussed directly below.
Like the actual-expense method, the deduction under the safe-harbor method is subject to a gross income limitation. The amount of the deduction computed using the safe-harbor method cannot exceed the gross income derived from the qualified business use of the home for the tax year reduced by the business deductions unrelated to the qualified business use of a home. Unlike the actual-expense method, however, taxpayers cannot carry over any excess to another tax year. If a taxpayer uses the actual-expense method for calculating the deduction and has had his or her deduction limited by the gross income limitation in that year, the taxpayer can deduct this amount in the next year he or she uses the actual-expense method, but cannot use the disallowed amount in a year he or she elects the safe-harbor method. This limit on carryovers for the safe-harbor method means taxpayers must be careful before electing it to be sure they will not lose any of their deduction.
Taxpayers sharing a home (for example, roommates or spouses, regardless of filing status) may use the safe-harbor method provided by the revenue procedure, but not for qualified business use of the same portion of the home.
Under the safe harbor, taxpayers who have a qualified business use of more than one home for a tax year may use the safe harbor for only one home, but they may use the actual-expense method for the other homes. If a taxpayer has more than one qualified business use of the same home, however, and uses the safe harbor, he or she must use the safe harbor for all of the business use of the home and thus will be limited to the $1,500 deduction for all of his or her businesses in the home.
There are also special rules for use of a portion of the home as storage space or to provide child care facilities, which are not addressed in this article.
EXCLUSIVE USE ON A REGULAR BASIS
According to the IRS, to qualify for the “exclusive use” test, taxpayers must use a specific area of their home exclusively for their trade or business, but the area does not need to be set off by a permanent partition. However, it must be used for the trade or business exclusively and at all times (not just during business hours), and any use of the space for nonbusiness purposes disqualifies the area, e.g., an office that is also used as a family room will not qualify. To qualify for regular use, the specific area of the home must be used on a regular basis; occasional or incidental use will not qualify. This determination is made based on all the facts and circumstances (see Publication 587, Business Use of Your Home (Including Use by Daycare Providers)).
WORK AT HOME IS FOR THE EMPLOYER'S CONVENIENCE, NOT THE EMPLOYEE'S
Many employees who work in their homes will not qualify for the deduction because they do it for their own convenience, not their employer’s.
It is not impossible to establish that the home office is for the employer’s, not the employee’s, convenience, but it is difficult.
If the use of the home office is necessary to allow the employee to perform his or her duties as an employee properly, or the use of the home office is necessary for the functioning of the employer’s business, it will be considered to be for the employer’s convenience. If the employer requires the employee to maintain a home office as part of his or her job requirements, the use of the home office is also considered to be the employer's convenience. As more people work at home and are not provided a space to work at their employer’s premises, it may be easier for employees to establish that it is being done for the employer’s convenience, say, to save the employer on the cost of providing workspace in the company’s office.
CALCULATING THE AMOUNT OF THE DEDUCTION
Calculating the home office deduction can be done one of two ways: the actual-expense method, under which the home office deduction amount is based on the actual expenses related to the use of the home office incurred by the taxpayer, or the new safe-harbor method, under which the deduction amount is determined by a formula based on the square footage used as a home office.
Whichever method is used to calculate the deduction, the amount of the deduction is subject to a gross income limitation, which, as discussed below, is calculated differently for each method. In addition, the carryforward rules for the deduction are different under each method. Under the actual-expense method, any excess of otherwise deductible expenses over the gross income limitation can be carried forward to the next tax year, subject to the same limitation (Sec. 280A(c)(5)). If the safe-harbor method is used, the amount of otherwise deductible expenses in excess of the limitation cannot be carried forward to future tax years.
ACTUAL-EXPENSE METHOD
Under the actual-expense method, taxpayers first must determine the percentage of their home that is used for business. This can be done by any reasonable method, but the most common approaches are either (1) the square-footage approach, in which the area used for business is divided by the house’s total square feet, or, (2) if the rooms in the home are all of a similar size, determining the percentage by dividing the number of rooms used for business by the total number of rooms in the house. For example, using the first method, a taxpayer whose office is 12 feet by 15 feet and whose house is 2,000 square feet uses 9% of the house in the trade or business.
After determining the percentage of the home expenses that the taxpayer can deduct as expenses for the business use of his or her home, the next step is to determine whether the deduction is subject to the gross income limitation. The deduction of otherwise nondeductible home expenses, such as insurance, utilities, and depreciation (with depreciation taken last), that are allocable to the business, is limited to the gross income from the business use of the taxpayer’s home, less:
- The business part of expenses the taxpayer could deduct even if he or she did not use the home for business (such as mortgage interest, real estate taxes, and casualty and theft losses that are allowable as itemized deductions on Schedule A, Itemized Deductions (Form 1040)); and
- The business expenses that relate to the business activity in the home (e.g., business phone, supplies, and depreciation on equipment), but not to the use of the home itself. Self-employed taxpayers cannot include their deduction for the deductible part of their self-employment tax as expenses in the second category.
The calculation of a taxpayer’s business use percentage and allowable deduction amount are performed on Form 8829, Expenses for Business Use of Your Home, for Schedule C filers, or on the “Worksheet to Figure the Deduction for Business Use of Your Home” in Publication 587 for employees and others.
THE NEW SAFE HARBOR
In January, the IRS released Rev. Proc. 2013-13, which gives taxpayers an optional safe-harbor method to calculate the amount of the deduction for expenses for business use of a residence beginning with the current tax year, 2013, for returns filed in 2014.
Individual taxpayers who elect this method can deduct an amount determined by multiplying the allowable square footage by $5. The allowable square footage is the portion of the house used in a qualified business use, but not to exceed 300 square feet. Therefore, the maximum a taxpayer can deduct annually under the safe harbor is $1,500. The IRS may update the $5 allowance from time to time, but it is not inflation adjusted. Because the up-to-$1,500 amount is a safe harbor, taxpayers who use the safe harbor cannot also deduct actual expenses related to qualified business use of the home for that year; however, business expenses that are unrelated to the use of the home (such as advertising) can be deducted.
To use the safe-harbor method, taxpayers must continue to satisfy all the other requirements for a home office deduction, including the requirement that the space in the residence used as an office be used exclusively for that purpose and the limitation that an employee qualifies for the home office deduction only if the office is for the convenience of the taxpayer’s employer. The safe harbor is elected on a timely filed original tax return, and taxpayers are allowed to change their treatment from year to year. However, the election for any tax year is irrevocable.
No depreciation is allowed for the years in which the safe harbor is elected. This may make this method more attractive for taxpayers who do not plan to stay in their homes a long time because they will then avoid the depreciation recapture that is required of taxpayers who took depreciation on their personal residences.
A taxpayer who itemizes deductions and uses the safe harbor for a tax year may deduct, to the extent allowable, any expense related to the home that is deductible without regard to whether there is a qualified business use of the home for that tax year (e.g., deductions for qualified residence interest, property taxes, and casualty losses). Taxpayers using the safe harbor deduct these expenses as itemized deductions on Form 1040, Schedule A, and cannot deduct any portion of these expenses from the gross income derived from the qualified business use of the home, either for purposes of determining the net income derived from the business or for purposes of determining the gross income limitation discussed directly below.
Like the actual-expense method, the deduction under the safe-harbor method is subject to a gross income limitation. The amount of the deduction computed using the safe-harbor method cannot exceed the gross income derived from the qualified business use of the home for the tax year reduced by the business deductions unrelated to the qualified business use of a home. Unlike the actual-expense method, however, taxpayers cannot carry over any excess to another tax year. If a taxpayer uses the actual-expense method for calculating the deduction and has had his or her deduction limited by the gross income limitation in that year, the taxpayer can deduct this amount in the next year he or she uses the actual-expense method, but cannot use the disallowed amount in a year he or she elects the safe-harbor method. This limit on carryovers for the safe-harbor method means taxpayers must be careful before electing it to be sure they will not lose any of their deduction.
Taxpayers sharing a home (for example, roommates or spouses, regardless of filing status) may use the safe-harbor method provided by the revenue procedure, but not for qualified business use of the same portion of the home.
Under the safe harbor, taxpayers who have a qualified business use of more than one home for a tax year may use the safe harbor for only one home, but they may use the actual-expense method for the other homes. If a taxpayer has more than one qualified business use of the same home, however, and uses the safe harbor, he or she must use the safe harbor for all of the business use of the home and thus will be limited to the $1,500 deduction for all of his or her businesses in the home.
posted by Nick Pennewell, CPA at 10:31 AM
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