The IRS has announced a new optional safe harbor method, effective for tax years beginning on or after January 1, 2013, for individuals to determine the amount of their deductible home office expenses (IR-2013-5, Rev. Proc. 2013-13). Being hailed by many as a long-overdue simplification option, taxpayers may now elect to determine their home office deduction by simply multiplying a prescribed rate by the square footage of the portion of the taxpayer’s residence used for business purposes.
The IRS cites that over three million taxpayers in recent tax years have claimed deductions for business use of a home, which normally requires the taxpayer to fill out the 43-line Form 8829. Under the new procedure, a significantly simplified form is used. The new method is expected to reduce paperwork and recordkeeping for small businesses by an estimated 1.6 million hours annually, according to the IRS. The new optional deduction is limited to $1,500 per year, based on $5 per square foot for up to 300 square feet.
The simplified method is not effective for 2012 tax year returns being filed during the current 2013 filing season, but it will become effective for 2013 tax year returns filed in 2014. Taxpayers may want to investigate now whether they could benefit from the election for the 2013 tax year. Acting IRS Commissioner Steven Miller advised upon announcement of the safe harbor that “The IRS … encourages people to look at this option as they consider tax planning in 2013.” A final decision on the election need not be made until 2014, when 2013 returns are filed.
Basic home office deduction rule
Under Code 280A, which governs the home office deduction rules on the simplified method election, a taxpayer may deduct expenses that are allocable to a portion of the dwelling unit that is exclusively used on a regular basis. This generally means usage as:
- The taxpayer’s principal place of business for any trade or business
- A place to meet with the taxpayer’s patients, clients, or customers in the normal course of the taxpayer’s trade or business, or
- In the case of a separate structure that is not attached to the dwelling unit, in connection with the taxpayer’s trade or business.
The new simplified method does not remove the requirement to keep records that prove exclusive use, on a regular basis, for one of the three designated uses listed above. It does help, however, in other ways.
Simplified safe harbor
Using the new simplified safe harbor method, a taxpayer determines the amount of deductible expenses for qualified business use of the home for the tax year by multiplying the allowable square footage by the prescribed rate. The allowable square footage is the portion of a home used in a qualified business use of the home, but not to exceed 300 square feet. The prescribed rate is $5.00 per square foot.
Taxpayers who itemize their returns and use the safe harbor method may also deduct, to the extent allowed by the Tax Code and regs, 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, the IRS explained. As a result, they will be able to claim allowable mortgage interest, real estate taxes, and casualty losses on the home as itemized deductions on Schedule A of Form 1040. These deductions do not need to be allocated between personal and business use, as is required under the regular method.
Taxpayers using the safe harbor cannot deduct any depreciation for the portion of the home that is used in a qualified business use of the home for that tax year. For many taxpayers, depreciation is the largest component of the home office deduction under the regular method that must be sacrificed if the new safe harbor method is used. Depending upon the value of your home and the space devoted to an office at home, using the regular method may prove to be the far better choice than electing the simplified method.
Taxpayers may elect from tax year to tax year whether to use the safe harbor method or actual expense method. Once made, an election for the tax year is irrevocable. The IRS has provided rules for calculating the depreciation deduction if a taxpayer uses the safe harbor for one year and actual expenses for a subsequent year. The deduction of expenses that are not related to the home, such as wages and supplies, is unaffected and those deductions are still available to those using the new method.
The IRS set various limits on the safe harbor, including:
- Taxpayers with more than one qualified business use of the same home for a tax year and who elect the safe harbor must use the safe harbor for each qualified business use of the home.
- Taxpayers with qualified business uses of more than one home for a tax year may use the safe harbor for only one home for that tax year.
- A taxpayer who has a qualified business use of a home and a rental use of the same home cannot use the safe harbor for the rental use.
If you are currently claiming a home office deduction, or if you have considered taking the deduction in the past but were discouraged by all of the paperwork and calculations required, you should consider whether the new, simplified safe harbor method is right for you. Please feel free to contact this office at (908) 725-4414 for further details.