During the year, it is always smart to evaluate whether you are utilizing the tax deductions that are available to you. The information below will help you determine whether you are legally entitled to the favorable "home office" deduction; the best method to compute this deduction, the consequences of depreciation recapture when you sell your residence, and other important tax information related to home-based businesses.
We hope that you find this newsletter helpful. As always, if you have any questions, please do not hesitate to contact us. We welcome and appreciate your referrals.
The favorable home office deduction can be computed using two different methods: the actual or the simplified method. The simplified method, instituted by the IRS in 2013, may seem inviting, but we generally find that using actual expenses generates a larger tax deduction. In short, simpler is not always better. Each year we review which method is most advantageous for our clients. The tax law allows us to adjust methods, if beneficial, on an annual basis.
Essentially, the simplified method is an alternative to tracking and substantiating your expenses. It is computed by multiplying the allowable square footage of your office space by $5.00, up to 300 square feet. If you use this method, the maximum deduction is $1,500 and no depreciation, utilities or other home office expenses can be claimed.
The actual method requires more record keeping and paper work, but as stated above, we find that it often generates a larger tax deduction. We multiply your actual home office expenses by the business use percentage (business square feet/total home square feet). Eligible expenses include utilities, depreciation, insurance, garbage, mortgage interest, real estate taxes, rent, condo fees, repairs, security system, snow plowing, etc. You may also deduct the expenses of allowable storage space if your business sells products and your home is your sole fixed-business location. The IRS states that lawn care fees are an "unrelated" expense that benefits only the part of a home that is not used for business; therefore, these expenses are not deductible unless you are in the child care business. Basically, all expenses incurred for the direct home office costs are eligible for a write off. These may include the cost of painting or repairing the home office and depreciation deductions for the furniture and fixtures.
You may also benefit on your automobile deduction since your home office is your "principal place of business". The costs of traveling between your home office and other work destinations are deductible expenses, unlike commuting costs which are not.
To qualify for the home office deduction, your business must meet the stringent "regular" and "exclusive" requirements. You must use your home office:
- as your principal place of business, or
- to meet with your clients, customers, patients or
- exclusive and regular use is located in a separate unattached structure on the same property as your home business.
If you are an employee who "telecommutes", you are entitled to the deduction for your home office only if your employer requires you to work at home because there is no on-premises office space available to you. Please be aware that if you are subject to AMT (alternative minimum tax) the deduction for the employee home office expense will not be beneficial to you since it is not allowed as a deduction for AMT purposes.
The amount you may deduct as home office expenses is subject to limitations based on the income attributable to the rules of home office usage. Any home office expenses that cannot be deducted because of this limitation may be carried over and deducted in future years.
Some clients are concerned about the effects of the home office deduction on the later sale of their principal residence. We generally find, however, that the savings from the current home office deduction outweigh any recapture of depreciation when you sell. When you sell your home you can exclude from income up to $250,000 of gain ($500,000 for married couples filing a joint return) from the sale of a personal residence if certain requirements are met. The only tax you may owe on the sale of your home office is called "depreciation recapture". This 25% capital gains tax (or lower depending upon your tax bracket) may be due on any depreciation you deducted since 1997 if you sell your home for a significant profit. The home office deduction still makes good financial sense, as you received a benefit from this deduction at higher ordinary tax rates in addition to all of the other deductions that go with the home office.
If you would like to discuss this or anything else further, do not hesitate to contact us. Hope you are having a great summer.