Deducting Home Office Expenses by Carolyn Flaherty

The home office deduction can prove to be a valuable deduction; particularly for self-employed taxpayers. The deduction may convert otherwise non-deductible expenses, (such as utilities, home owner’s insurance, association fees and more) into deductible business write offs that will reduce self-employment tax liabilities. However, the deduction is one that has been scrutinized by the IRS due to abuses by taxpayers and proper record-keeping can be onerous.

Therefore, for tax years starting in 2013, the IRS has provided an optional safe-harbor method to calculate the home office deduction. Under the safe-harbor method the taxpayer will look to the square footage of the area used exclusively for business and simply multiply that by $5. The maximum allowable square footage for figuring the safe-harbor deduction is 300. As such, the maximum safe-harbor deduction is $1,500.

Interestingly, taxpayers are allowed to switch back and forth from year to year between the safe-harbor and the actual expense method. Therefore, in a year when significant repairs and maintenance work was done: the taxpayer may wish to use actual expenses whereas in other years, it may be easier to use the safe-harbor. Note that the safe-harbor election once made for a tax year is irrevocable for that year.

Depreciation expense cannot be taken in a year the safe-harbor election is made, but may be taken in subsequent years when the actual expense method is used.

Whether the safe-harbor or actual expense method is used, the home office deduction cannot reduce the qualified business income below zero. However, the actual expense method allows the unused deduction to be carried forward to subsequent profitable years. The safe-harbor rules do not. Additionally, the actual expense carry over can NOT offset business income in a year when the safe-harbor rules are used. The carry forwards may only be applied to a future tax year when the actual method is utilized.

Regardless of the method used, your home office must be used exclusively for business and must also be your principal place of business. Exclusive use specifies that the personal use of your home office is no more than would be permitted in an office building. If you work at multiple sites, your home office is still your principal place of business if you regularly meet customers or clients there.

List of potential costs deductible under actual expense method:

·         Direct expenses such as business phone lines, computer equipment etc.

·         Indirect expenses (in proportion to the square footage of the office as compared to the total home), the following are common expenses considered in the deduction calculation:

1.       Utilities

2.       Home owner’s insurance

3.       Association fees

4.       Security costs

5.       General repairs and maintenance

6.       Depreciation or rent

7.       Mortgage Interest

8.       Property taxes