The IRS has simplified the home office deduction. The calculation of the actual deduction is complex and requires extensive recordkeeping. However, taxpayers now have the option to claim a safe harbor home office deduction in lieu of calculating and substantiating the actual amount of the home office deduction.
Background and Actual Deduction
To qualify for the home office deduction, the area in the home used for business must be used exclusively and regularly in accordance with one of the following three tests: the principal place of business test; the place for meeting patients, clients or customers test; or the separate structure test.
Principal place of business. Your home office is your principal place of business if it satisfies either a "management or administrative activities" test or a "relative importance" test. You satisfy the management or administrative activities test if you use your home office for administrative or management activities of your business, and if you meet certain other requirements. You meet the relative importance test if your home office is the most important place where you conduct your business, in comparison with all the other locations where you conduct that business.
Home office used for meeting patients, clients or customers. You can satisfy this test if you use your home office, exclusively and on a regular basis, to meet or deal with patients, clients or customers. The patients, clients or customers must be physically present in the home office.
Separate structures. A separate, unattached structure on the same property as your home can qualify as a home office if it is used exclusively and regularly in connection with a business activity.
If your home office area satisfies the rules discussed above, the actual calculation of your home office deduction would include:
- The "direct expenses" of the home office, such as the costs of painting or repairing the home office, depreciation deductions for furniture and fixtures used in the home office, etc.; and
- The "indirect" expenses of maintaining the home office, such as the properly allocable share of utility costs, depreciation, insurance, etc., for your home, as well as an allocable share of mortgage interest, real estate taxes and casualty losses.
New Safe Harbor
The IRS is now providing a simplified method for determining the amount of a home office deduction. Effective for tax years beginning on or after Jan. 1, 2013, a taxpayer can elect to use the safe harbor with respect to his or her qualified home office (i.e., the area meets one of the three tests described above).
The safe harbor is calculated as $5 per square foot of qualified use (up to 300 square feet). This safe harbor calculation provides an alternative to the calculation, allocation, and substantiation of actual expenses that would otherwise be required. The safe harbor calculation may substantially reduce the record keeping burden for an individual who qualifies for a home office deduction.
For more information, contact your KSM advisor.