It’s our favorite time of the year in the US – Tax Time.
Every year about this time business owners all magically become obsessed about the stimulating topic of income tax law.
Since many online business owners are home-based, I thought I’d do a little write-up about the IRS’ simplified home office deduction.
Historically, the home office deduction has been a difficult thing to figure out for small business owners.
Assuming you qualified to take the deduction (see below), you still had to figure out how to calculate the amount of the deduction. That is no easy task.
Both homeowners and renters are permitted to claim a deduction for a home office.
In a nutshell, you need to take the number of square feet in your home that you devote exclusively to your home office and divide that by the total number of square feet in the home to arrive at the percentage dedicated to the home office.
Then, you can deduct that percentage of the expenses related to the home. These expenses may include mortgage interest, insurance, utilities, repairs, and depreciation.
An additional complication is that with the traditional home office deduction, you are entitled to claim a proportional share of the depreciation on the home, and if you later sell the home, you have to recapture the previously claimed depreciation.
Depreciation calculations can be very perplexing, and recapture rules even more so.
Business owners sometimes make the mistake of thinking that they will simply not claim the depreciation portion of the deduction and, therefore, will not be required to do the complicated computations or recapture the claimed depreciation later if they sell the home.
Unfortunately, due to the oddities of the IRS rules, depreciation is calculated on an “allowed or allowable” basis.
So, if depreciation was “allowable” you are treated for this purpose as having taken it, whether you did or not.
Therefore, you can end up in the worst case scenario of not having received the benefit of deducting the depreciation, but still being required to recapture it on the sale of your home as if you had claimed the depreciation, thereby potentially increasing the tax you may owe.
The Simplified Home Office Deduction
I guess the IRS got tired of having to audit all the home office deductions that were being miscalculated, so beginning with tax year 2013, a simplified procedure was allowable.
In effect, the IRS created a “standard deduction” for the home office. Under the new rule, you are allowed to deduct $5 per square foot of space devoted exclusively to your home office, up to a maximum deduction of $1,500.
The deduction is also limited by the fact that it cannot exceed your gross income from the business use of the home less your business expenses.
Using the simplified method, you are not permitted to claim any depreciation and you are not required to recapture allowable depreciation later if you sell the home.
The simplified home office deduction can be a blessing or a curse, because your record keeping and calculations are simplified but you may end up with a smaller deduction.
Even if you choose to use the simplified method to calculate your home office deduction, you are still allowed to claim your allowable itemized deductions (mortgage interest, real estate taxes, etc.) on Schedule A of your Form 1040 if you itemize.
Here is a video from our friends at the IRS describing the simplified deduction:
Qualifying for the Home Office Deduction
Not everybody is entitled to claim the home office deduction. In order to claim the deduction, the IRS requires you to meet the following requirements:
- You must regularly use part of your home exclusively for conducting business. For example, if you use an extra room to run your business, you can take a home office deduction for that extra room.
- You must show that you use your home as your principal place of business. If you conduct business at a location outside of your home, but also use your home substantially and regularly to conduct business, you may qualify for a home office deduction. (For example, if you have in-person meetings with patients, clients, or customers in your home in the normal course of your business, even though you also carry on business at another location, you can deduct your expenses for the part of your home used exclusively and regularly for business.)You can deduct expenses for a separate free-standing structure, such as a studio, garage, or barn, if you use it exclusively and regularly for your business. The structure does not have to be your principal place of business or the only place where you meet patients, clients, or customers.
The home office deduction rules can quickly become very complex, especially if you elect not to use the simplified method of calculating the deduction. I want to put the disclaimer here that this article is only provided as a quick overview and there are many other aspects of this deduction that can come into play.
For more information about the deduction, you may review these resources from the IRS: