The Home Office Deduction
If you're self-employed, the home office deduction can save you taxes because it can reduce net business income reported on Schedule C (or Schedule F for farmers). Whether you're a renter or homeowner, you may qualify for the home office deduction.
There are two options available for claiming the home office deduction:
- The Simplified Safe-Harbor Method (Simplified Method for short)
- The Actual Expense Method
The Simplified Method for claiming the home office deduction began in 2013. Before 2013, only the actual expense method was, and still is, available. The actual expense method requires Form 8829 to be completed, where actual indirect costs of operating the residence are allocated to the home office according to an allocation percentage.
The National Taxpayer Advocate recommended that Congress create an optional standard home office deduction based on a simple formula that eliminated the allocation calculation and substantiation of actual expenses, making the completion of Form 8829 unnecessary.
As a result, starting in 2013, you now have the option of using either the new simplified method or the actual expense method for figuring your home office deduction. Electing the safe-harbor method is done on a timely filed original tax return. If you use the actual expense method you must complete Form 8829.
Revenue Proc. 2013-13 contains the rules for the safe-harbor method. Keep in mind, if you use the simplified method, you must still continue to satisfy all the other requirements for a home-office deduction, such as using the home office regularly and exclusively for business activities.
An employee with a home office who receives advances, allowances, or reimbursements for expenses related to his or her home office use under a reimbursement or expense allowance arrangement with his employer may not use the safe-harbor method.
Under the simplified method, the standard home office deduction amount is $5 per square foot up to 300 square feet of the area used regularly and exclusively for business. The maximum deduction is $1,500. The deduction may not exceed business net income (gross income derived from the qualified business use of the home minus business deductions).
If you share your home with someone else who uses the home for a separate business that qualifies for this deduction, each of you may make your own election, but not for the same portion of the home.
If you conduct more than one business that qualifies for this deduction in your home, your election to use the simplified safe-harbor method applies to all your qualified business uses of your home. However, you are still limited to a maximum of 300 square feet for all of the businesses you conduct in your home that qualify for this deduction.
If you conduct more than one business that qualifies for the deduction, allocate the actual square footage used (up to a maximum of of 300 square feet) among your qualified business uses in any reasonable manner you choose. However, you may not allocate more square feet to a qualified business use than you actually use in that business.
You May Switch Back and Forth
You make the decision to use the simplified safe-harbor method year to year. This means you may switch back and forth each year from the actual expense method to the simplified method. However, once an election is made to use the safe-harbor method for a particular tax year, it is irrevocable for that particular year.
No depreciation is allowed
No depreciation is allowed for the years in which the simplified safe harbor option is elected. Depreciation is allowed in the years in which the actual expense method is used. Revenue procedure 2013-13 has examples of how depreciation is calculated in a year subsequent to a year the safe-harbor method is used.
No Depreciation Recapture Under the Simplified Option
Since no depreciation deduction may be claimed when using the safe-harbor method, recapture of depreciation is not necessary if you sell your home. The depreciation deduction allowable for that portion of the home used in a qualified business is deemed to be zero.
Though homeowners using the new safe-harbor option cannot depreciate the portion of their home used in a trade or business, they can claim 100% of allowable mortgage interest, real estate taxes, and casualty losses on the home as itemized deductions on Schedule A.
Advantages and Disadvantages of the Simplified Option
The main advantage of the simplified option is its simplicity. You don't have to deal with Form 8829, which includes four sections and 43 lines. Just follow the instructions for line 30 of Schedule C.
Unlike the actual expense method, where you may carry over the amount that is not deductible because of the income limitation, under the safe-harbor method, the portion of the safe-harbor amount that is not deductible because of the income limitation may not be carried over and is lost forever.
For example, if tentative net profit on Schedule C is $1,200 and your safe-harbor deduction is $1,500 (the maximum), the excess $300 over tentative net profit may not be carried over to the following year and is lost forever.
On the other hand, if you use the actual expense method, the amount by which actual expenses exceed tentative net profit on Schedule C may be carried over to the following year.
You Must Have Business Income
If you have no income for the year in your business or profession, you may not claim the home office deduction. For example, if you're a writer and do not receive an advance during the year or any income related to your writing, you may not claim the home office deduction.
Home Office Deduction Limited to Net Business Income
If you have net income from your business, the home office deduction is limited to your net income (gross income derived from the qualified business use of the home minus business deductions) regardless of the method you use.
May Not Create A Loss
Since you may only claim a home office deduction up to the amount of net profit from your business, a net loss may not be created by claiming the home office deduction.
If Your Sell Your Home
If you sell your home during the year, you must increase the tentative profit by any net gain or decrease tentative profit by any net loss that is allocable to your home office and reported on Schedule D or Form 4797.
Direct and Indirect Expenses
If you use the actual expense method to compute your home office deduction you may deduct direct and indirect expenses associated with your home.
Direct expenses are expenses directly related to the actual space used for your home office and 100% deductible. For example, if you pay $200 to paint your office, you may deduct the $200 as a direct expense on Form 8829.
If you use the safe-harbor method for claiming the home office deduction, you may not claim direct expenses in addition to the standard home office deduction amount. You may only deduct $5 per square feet up to 300 square feet, for a maximum standard home office deduction of $1,500.
Indirect expenses are expenses associated with the entire residence. For example electricity, insurance, water, the cost of a burglar alarm monitoring service, and trash disposal.
Indirect expenses are allocated to your home office using an allocation percentage. A common basis for figuring an allocation percentage is square footage.
For example, if your residence is 2,000 square feet and your home office is 200 square feet, your allocation percentage is 10% (200/2,000). Simply multiply your annual indirect costs, such as electricity, water, trash disposal, and rent (if you're renting your residence) by 10% to determine your deductible amount.
Business Expense Not Related to Home
You may deduct regular business expenses not related to the home.
Real estate taxes, mortgage interest, and casualty and theft losses that are not allocable to the business-use portion of your home may be deducted on Schedule A as itemized deductions.
How to Claim the Home Office Deduction
Under the simplified option, for line 30 of Schedule C, you enter (a) the total square footage of your home on the first line, and (b) the square footage of the part of your home used for business on the second line.
Use the Simplified Method Worksheet in the Schedule C instructions to figure the amount to enter on line 30.
Actual Expense Method:
Complete Form 8829, Expenses for Business Use of Your Home.
On Schedule C, Profit or Loss From Business:
- Enter the home office deduction on line 30
- Subtract Line 30 from line 29, Tentative profit or (loss)
- Enter the result on line 31, Net profit or (loss)
Carryover of Unused Home Office Expenses
If you use the actual expense method, and expenses were disallowed because of the income limitation, you may carry the disallowed expenses over to the following year and treat them as home office expenses of that year.
The carryover expenses plus the actual expenses in the carryover year are also subject to the income limitation.
For example, if 2015 tentative profit was $2,000 and your home office expense was $2,500, only $2,000 may be claimed in 2015. The remaining $500 may be carried over to 2016 and treated as home office expense for that year.
If you use the simplified option to claim your home office deduction, no carryover is permitted and is lost forever.
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- Return to the Business Deductions Table of Contents to find related links