Anyone with a home office will have a new decision while preparing the 2013 tax return: Should I take the new “simplified” home office deduction or go with the standard, traditional method? The answer is trickier than you may think.
The Internal Revenue Service (IRS) came up with the optional simplified option “to combat complexity” and provide an easier way to determine the amount of expenses you can deduct for a home office. It estimates the new method will reduce the paperwork and recordkeeping burden on small businesses by 1.6 million hours annually. There's a brief video about the simplified home office deduction on the IRS's YouTube channel.
“Some people were missing out on taking the home office deduction because they didn’t want to do the paperwork,” says Lisa Greene-Lewis, Turbotax’s CPA and Tax Expert, based in San Diego. Although an estimated 26 million Americans have home offices, just 3.4 million claim home-office deductions.
(MORE: Secrets of Claiming a Home-Office Deduction)
The Irony in Tax Simplicity
Ironically, although the new write-off method is simpler, it will make tax-preparation more complicated for some who want to claim the home office deduction. That’s because they’ll need to calculate their taxes using the new and old method to see which will provide the biggest write-off and be best for their tax bill over the long run.
Still, says Greene-Lewis: “Anything that helps people keep more of their money is a good thing.”
With the simplified option, you just deduct $5 per square foot of your home office, with a maximum write-off of $1,500 (which works out to a limit of 300 square feet) on Schedule C. You can still deduct office expenses such as supplies and advertising on Schedule C and all of your mortgage interest and property taxes, if you itemize, on Schedule A.
So, for instance, if your home office is 200 square feet, you’d deduct $1,000. The size of the deduction can’t exceed the gross income from the business use of the home, though. Of course, since we’re talking taxes, things are slightly more complicated than that; the IRS’s Simplified Method Worksheet in Form 587 shows how to run the numbers.
(MORE: 7 Key Changes to This Year's 1040)
Unlike the traditional method, with the simplified method you don’t need to figure out the pro-rated amount of your mortgage interest or rent, utilities and property taxes (if you’re a homeowner) or the pro-rated portion of repairs or maintenance that benefit your home office in order to calculate their “business use."
No Need to Complete a 43-Line Form
And if you go simplified, you won’t need to complete the 43-line Form 8829, Expenses for Business Use of Your Home. Not that this form is a bear. “It really isn’t that difficult, especially if you use tax software,” says Greene-Lewis.
“I think people who are afraid to deal with the home office deduction should take advantage of the simplified method, because otherwise they’re leaving money on the table,” says Greene-Lewis.
Just don’t assume that the simplified deduction is automatically the version you should use if you have a legitimate home office. (The basic rule: it must be used exclusively and regularly as your principal place of business or a setting where you conduct business or to meet with clients, customers or patients. If you’re an employee, you can only claim the home office if it’s used for the convenience of your employer.) You can read more in IRS Publication 587.
“You’ll want to see which of the two methods will provide you with the bigger deduction,” say Gregg Wind, a CPA with the Wind & Stern firm in Los Angeles. “If they’re equal, you might have an incentive to use the simplified version because it’s easier.”
(MORE: A Guide to Self-Employment Retirement Plans)
Which Method Might Be Best
Wind says people with large homes and big home offices will likely find the traditional computation will yield the bigger write-off since their deductible expenses will exceed $1,500. “I think the old version will provide a larger deduction for most of my clients with home offices, so I think they’ll stay with that method,” he adds.
Greene-Lewis says: “The deciding factor will be if you pay a lot in mortgage interest and property taxes. In that case, you’ll probably want to go with the old method.”
The Effect on Selling Your Home
You’ll also want to weigh the effect of claiming a home office on the eventual sale of your home, if you’re an owner.
The “old” method lets you depreciate the portion of your home used as an office, which boosts your current write-off but leads to a tax hit when you sell. The simplified method doesn’t allow you to claim depreciation, so you won’t be smacked with a tax bill down the road. (You can, however, still depreciate furniture and equipment in your office.)
Normally, when you sell your home, you don’t owe taxes on up to $250,000 in profit (up to $500,000 if you’re married filing jointly). But if you’ve claimed depreciation for a home office, the amount of that write-off is treated as a taxable gain and taxed at — get this — a 25 percent rate.
The Truth About Recordkeeping
The IRS might lead you to believe that the simplified method is best because the traditional method requires so much recordkeeping. And, tax pros say, some people haven’t claimed their home offices in the past because they’re not pack rats.
But the truth is, you almost surely have (or can easily get) documentation for the amount you paid in 2013 for mortgage interest, property taxes and utilities. “The thing about the home office deduction is that it should be pretty easy to prove your expenses,” says Wind.
Audits and Home Offices
One more thing: Don’t skip claiming a legitimate home office because you’re worried doing so will lead to an IRS audit.
“My opinion is that deducting a home office probably doesn’t raise your chance of an audit,” says Wind. “But it’s a good idea to take pictures of your office, in case you do need to prove to the IRS that the space was used exclusively for work.”
Whichever method you do choose, you won’t be obligated to use it in the future. If you take the simplified deduction this year but want to switch to the traditional method for your 2014 taxes, you can. Simple, huh?