New Home Office Deduction Safe Harbor

For small business owners, home office deductions can be an important tax break. Instead of renting space, many businesses can be operated from home, lowering the business's overhead costs and reducing the owner's tax liability.

Until now, home office deductions have required a calculation method that involved depreciation and other factors. It brought confusion and complexity to tax reporting for otherwise simple returns. To simplify the process, the IRS has issued a new Revenue Procedure which provides an optional safe harbor method that individual taxpayers may use to determine the amount of deductible expenses attributable to business use of a residence during the taxable year.

The safe harbor method is an alternative to the calculation, allocation, and substantiation of actual expenses for the home office. It is effective for taxable years beginning on or after January 1, 2013. It won't be available this filing season for 2012 returns. Starting with the 2013 tax year, home business owners have the option of multiplying the square footage used for business purposes by $5, for a maximum deduction of $1,500.

Even using the safe harbor you still must meet the requirements for the deduction for business use of the home.

If you are an employee, you can only deduct the home office if it is for the convenience of your employer. If your employer wants you to work at home to save the employer money on office space, you can claim the home office deduction. It's not enough that the home office is helpful, it must actually be required by the employer. If you are permitted to work at home because you asked, that is not for the convenience of the employer - that is for your convenience, and you don't qualify for the deduction.

If you are self-employed, in order to qualify to deduct a portion of home-connected expenses such as utilities, rent, depreciation, homeowner's insurance, mortgage interest, real estate taxes, maintenance and repairs, you must be able to prove: (1) that you regularly use part of your home exclusively for a trade or business, and (2) you must also be able to prove at least one of the following:

  • you use your home as your principal place of business;
  • you meet patients, clients, or customers at home; or
  • you use a separate structure on your property exclusively for business purposes

The requirement that part of your home be used exclusively for a trade or business is a tough one. Exclusive use means that you use a portion of your home only for business. If you use a room or part of your home for business and for personal use, you don't qualify for the deduction. If your home office doubles as a guest room, that's not exclusive use for business.

If you are not using the new safe harbor calculation, you must figure the amount of your deduction on IRS Form 8829, Expenses for Business Use of Your Home. Deduct 100% of expenses that are directly related to the home-office. This can include painting, cleaning and the premium for a home-office rider on your homeowner's insurance policy. Ditto for your office telephone line and utilities if you have separate hookups.

You are also allowed to deduct a percentage of indirect expenses that relate to your entire residence. These include mortgage interest, real estate taxes, condo fees, rent, depreciation (over 39 years), utilities, security, garbage pickup, maintenance, repairs, insurance, snow removal, and so on.

What percentage of these expense can you deduct? If you follow the instructions for Form 8829, it will lead you through a square footage analysis. Count only living space in figuring the percentage (not your garage, unfinished basement or covered patio).

Taxpayers using the new calculation option cannot depreciate the portion of their home used in a trade or business. But they can claim 100% of allowable mortgage interest, real estate taxes and casualty losses on the home as itemized deductions on Schedule A. These deductions don't have to be allocated between personal and business use as is required under the regular method.

Business expenses unrelated to the home, such as advertising, supplies and wages paid to employees are still fully deductible.