Do You Work from Home? Here’s a simple method for claiming your tax deduction
By Jerry Bobal
Many people today either work out of their homes on a full-time basis or bring work home at night or on the weekend. Invariably, the question of whether this qualifies for a home office
deduction arises. The home office deduction is available to employees and self-employed individuals, including someone who “moonlights” on a part-time basis at a second job. The office must be used exclusively and regularly as a principal place of business or as a place to meet or deal with customers in the normal course of business, or in connection with the business if the space is a separate structure from the residence. As such, it is easier for a self-employed individual to satisfy these tests. For an employee, the office must be used for the convenience of the employer and must be used exclusively and regularly by that employee in job-related activities. Typically, this test would not be met if the employee has an employer-provided office. So if you work out of an office in your home over the weekend, you probably won’t qualify. On the other hand, telecommuters with no office provided will qualify.
THE OFFICE MUST BE USED EXCLUSIVELY FOR BUSINESS PURPOSES. THEREFORE, ANY PERSONAL USE DISQUALIFIES IT.
As mentioned, the office must be the principal place of business. In some cases, this is easily satisfied (a consultant with no other office). In others, it takes an examination of the individual facts and circumstances. For an employee, the primary consideration is the relative importance of the activities performed at the employer-provided office vs. the home office and the time spent at each. The home office will always qualify if it is used exclusively and regularly to conduct administrative or management activities of the business and there is no other fixed business location where the individual conducts substantial administrative or management activities. Internal Revenue Service Publication 587 provides an example of a self-employed plumber with no other place of business, who maintains an office in his or her home that is used regularly and exclusively for the administration and management of the business. The office qualifies as a home office.
ONCE IT HAS BEEN DETERMINED THAT THE OFFICE QUALIFIES, HOW IS THE DEDUCTION ACTUALLY CALCULATED?
Expenses such as utilities, insurance, real estate taxes, and mortgage interest are all eligible for the deduction. These are typically referred to as indirect expenses, since they are associated with the monthly operation of a home.
Expenses are normally allocated based on the square footage of the office compared to the total square footage of the home. For example, if the home office represents 15 percent of the total square footage of the home, 15 percent of the mortgage interest, real estate taxes, insurance, utilities, and maintenance are deductible as home office expenses.
Expenses cannot increase or decrease the net loss of a business except for mortgage interest and real estate taxes (which are allowed even if these create a loss). Any expenses not allowed as a result of the net income limitation may be carried forward.
The calculations for home office deductions are done on Form 8829 (Expenses for Business Use of Your Home), and deducted on Schedule C if the taxpayer is a sole proprietor, or on Schedule A as a miscellaneous itemized deduction as an employee.
Beginning with 2013 tax returns, the IRS instituted a simplified method for calculating the home office deduction. This method eliminates the need for record keeping of home office expenses—the taxpayer simply multiplies the square footage of the office (not to exceed 300 square feet) by $5 with a maximum deduction of $1,500. Taxpayers can choose on an annual basis whether they want to use the simplified method or calculate the deduction based on actual expenses.
SHOULD YOU ELECT THE SIMPLIFIED METHOD?
If the taxpayer chooses to use the simplified method, he or she may still deduct the full amount of mortgage interest and real estate taxes on Schedule A. If the actual method is used, part of the interest and taxes are deducted as a business expense and the rest as an itemized deduction.
A taxpayer who chooses to use the simplified method must still meet the requirements mentioned earlier in order to qualify for the deduction. One drawback of the simplified method is that if the expenses exceed the business income, the excess amount cannot be carried forward to a subsequent year.
The obvious answer is to select a method that delivers the greatest tax deduction, however any expenses in excess of income from the business are lost forever if the simplified method is used. If the actual method is used, excess expenses can be carried forward and deducted in the future.
The new simplified method will make taxpayers’ lives easier, but can put certain deductions at risk.