There are two methods for figuring your home office. This is new-ish. Before tax year 2013, there was only one method.
The old fashioned ‘regular method’ has a few steps. When calculating a home office deduction using the regular method, it is necessary to determine the percentage of home that is used for the home office. The total of qualified household expenses, categorized, are then applied against the percentage to determine the deductible amount. In addition, there is a depreciation deduction taken on the percentage of your home that qualifies as your home office. The home office deduction cannot exceed your net business income from business use of the home. The excess can be carried over into the next year and used to reduce taxable future business income. If you sell or otherwise dispose of your home, you will be subject to recapture of depreciation.
Since 2013, the IRS allows taxpayers to use a simplified, ‘safe harbor’ option when figuring the deduction for business use of their home. This safe harbor method allows you to deduct the square footage of your home office at $5 per square foot up to a maximum $1,500. Your home office must be 300 square feet or less. The deduction cannot exceed your net business income from business use of the home, and you cannot carry unused amounts over into the following year. When the simplified method is used, there is no depreciation deduction on your home office. If you sell your home, there will be no depreciation to recapture.
Why would someone choose one method over the other?
A lot of times, the regular old fashioned method just gets you a much higher deduction. Your home office may be in an area where your expenses are very high and you will benefit from tracking your qualified expenses. If your office space is larger than 300 square feet you may not be getting the full benefit with the simplified methods $1,500 limitation. You may have had a substantial loss this year but know that your income will be higher next year and being able to carry any unused deduction to the following year would be a good plan.
On the other hand, the simplified method is simple. You do not need to keep track of your household expenses. Maybe you anticipate moving and do not want to deal with recapture and the probable future tax consequences that may cause. You may have already paid off your home or have a very low mortgage (or rent) and your qualified expenses do not add up to an amount high enough to beat the simplified $5 per square foot.
There is a 15-page document on the Internal Revenue Service website if you are interested in reading the tax talk. https://www.irs.gov/pub/irs-drop/rp-13-13.pdf It’s a long boring read.. but if you must, enjoy!
There is much more to the home office deduction than I can fit into a blog, but no need to worry! Call today to schedule an appointment or use the handy contact page. We can discuss the rules for your home office during your appointment!