Home Office Deduction Safe Harbor

Background

Certain taxpayers who work from home have been eligible to claim a tax deduction on their 1040 for expenses related to the part of their home used for business purposes. To claim the deduction, the following requirements must be met. The new safe harbor option does not change these requirements.

• The portion of the home must be used regularly and exclusively either as the principal place of business for any trade or business of the taxpayer, or as a place of business that is used by patients, clients, or customers in meeting with the taxpayer in the normal course of business.
• In the case of a separate structure not attached to the home, the space must only be used “in connection with” the taxpayer’s business, a less stringent test.
• In some cases, the use of a part of the home as business storage space or to provide child care facilities qualifies for the deduction.
• In the case of an employee, the work must be performed at home for the convenience of the employer to qualify for the deduction.

The existing method of calculating the deduction is based on actual expenses. Some expenses are direct, such as repairs to the business portion of the home. Others, such as utilities and insurance, must be allocated between business and personal use based on square footage. This includes items which are itemized deductions, like mortgage interest and real estate taxes. Depreciation of the home, and depreciation recapture on sale of the home, further complicate the deduction.

The New Safe Harbor

Beginning in 2013, taxpayers can elect the safe harbor method, which is very simple:

• Multiply the square footage of the home office by $5, with a maximum deduction of $1,500.
• Actual expenses cannot be taken on top of the safe harbor.
• Depreciation cannot be taken.
• Taxpayers who use the safe harbor and who itemize can deduct mortgage interest and real estate taxes to the full extent allowed on Schedule A – no allocation to business use is required.

Business Income Limitation

Using either method, the amount of the deduction is limited to the amount of income from the business. A taxpayer using the actual expense method can carry over unused deductions to the next tax year. However, amounts not used under the safe harbor cannot be carried over.

Pros and Cons of the Safe Harbor Method

Pros

• Eliminates the need for special record-keeping for the home office deduction – the only information needed is the square footage of the area used for business.
• Greatly simplifies the calculation of the deduction at tax time.
• May result in a lower deduction than the actual expense method.
• Deductions that can’t be used in the current year can’t be carried over.

Cons

• May result in a lower deduction than the actual expense method.
• Deductions that can’t be used in the current year can’t be carried over.

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