By Richard Schwartz, CPA
In Part 1 of Home Office Deductions, we covered determining the qualifying space, regular and exclusive use, and multiple business locations. In Part 2, we’ll look at determining dollar amounts of your deduction, what to do if you’re an employee, selling your house, and keeping good records.
How To Determine Deduction Amounts:
% of Cost Method
Currently there are two ways to determine the dollar amount of your home office deduction. Taxpayers can either calculate a percentage of their true costs or they can use the new Simplified Home Office Deduction Method. Using the percentage of actual cost method, the taxpayer would determine the deduction by dividing the square foot area of the home office by the total square foot space of the entire home. The home office deduction is calculated by totaling indirect home expenses such as mortgage interest (or rent if the home is not owned), real estate taxes, homeowners insurance, utilities and maintenance costs multiplied by the calculated square foot percentage. Additionally, the home office calculation may include direct expenses as well as a deduction for tax depreciation (amortizing the original cost of your home over a period of years).
Beginning in 2013, the IRS allows taxpayers to use the Simplified Home Office Deduction Method. Electing this second method, taxpayers determine their deduction based upon $5 per square foot of home office space, not to exceed 500 square feet, or a $1,500 total deduction. This new method certainly simplifies the calculation of the deduction and the recordkeeping required, but typically will result in a lower deduction for taxpayers. Using either method, taxpayers may also qualified for multiple home offices in the same home if separate home office spaces exist and both qualify. Examples would be each spouse utilizing separate home office spaces or if separate spaces exist for separate businesses.
What if you’re an Employee:
One key qualification to be aware of if you are an employee is that the home office must be for the convenience of the employer (and not the convenience of the employee). Employees that do work in their “home office” late at night or during the weekend, will not qualify for a home office deduction if they also have a place to do this work at the employer’s office, but choose to do the work at home rather than at their employer’s office. If you are a self-employed individual taking the deduction, you have more flexibility with meeting the rules when another job site exists in addition to your home office.
What if you Sell your Home:
When you sell your house, be aware there could be tax consequences related to a sale when you have had a home office deduction claimed on your previous years’ tax returns. Although the home office that is included within the dwelling of your home will fall under the capital gain home exclusion rules, any depreciation expenses relating to the prior years’ home office deductions, whether actually taken on previous years’ tax returns or not, would be included as income and taxed federally at a 25% tax rate, and taxed at the state level as well when the home is sold. One final note, if the home office is a separate dwelling unit from the home such as a converted barn or detached garage, additional taxes from the home sale could exist as well in addition to any depreciation being recaptured as income.
Remember, Keep Good Records and Photos:
But don’t think the IRS won’t question the validity of such a deduction if you are ever audited. Keeping good receipts as well as taking a picture of the home office space and keeping it with your tax records will go a long way in substantiating and qualifying your home office deduction, and in giving you peace of mind as well. If you meet the rules, claim the deduction. The tax benefits relating to a qualified home office deduction on your tax return could be substantial, depending upon the size of the space, percentage of use and the resulting dollar value of the deduction claimed. In addition to federal and state taxes saved resulting from the home office deduction, if you are self-employed the tax savings will also include self-employment taxes. Thus, if you meet the rules, this deduction is one not to be missed.