New Home-Office Deduction Rules Revealed

The Internal Revenue Service is offering business owners with home offices a new way to calculate their home-office deduction, but experts say the old way may work just …

The Internal Revenue Service is offering business owners with home offices a new way to calculate their home-office deduction, but experts say the old way may work just as well or better for many people. The new method, called the “safe harbor” option, complicates the value depreciation method while simplifying the overall deduction, which is reduced to a flat rate of $5 per square feet of office space for up to 300 feet. While that may benefit some people, those who are moving or who use more space than that will clearly want to think about sticking to the old rules. For more on this continue reading the following article from TheStreet.

This year, the Internal Revenue Service allows a new method of deducting expenses for home offices. You can still deduct for home office space using the old method — and this new "safe harbor" option, which the IRS calls "simplified," has calculation wrinkles that may not be for everyone.

The new method allows you to deduct a flat $5 per square foot of dedicated office space in your home, up to a maximum of 300 square feet. Three reasons this might be for you:

1. If you are just starting to take the home office deduction, you can forget about depreciation recapture, a required adjustment when you sell your home. If you took the old home office deduction, including depreciation of your home office space, you still need to keep records of the depreciation claimed in earlier years and recapture that depreciation when you sell your home. Note that you also need to maintain these records even if you start taking the safe harbor amount, since you’re permitted to switch between deduction methods from tax year to tax year.

2. In the past when calculating the home office deduction, you gathered utility bills, mortgage interest, real estate taxes, repair bills and other documents to determine the amount attributable to the home office. This isn’t needed under the new rule.

3. Under the old method, any amount for real estate taxes and mortgage interest claimed under the home office deduction gets subtracted from those expenses for use on your Schedule A tax form for itemized deductions. Again, this is no longer required under the safe harbor rule.

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Depending on your situation, you might want to stick with the old rules, however. For one, the new provision’s 300-square-foot deduction limit may be plenty for some home office workers but there are likely many exceptions. A dedicated waiting area, for example, could easily push your square footage beyond this allowable maximum.

Also, if your home office expenses exceed your gross income less business expenses, the new method, unlike the old, forbids you to carry over the excess to future years. If you switch to the safe harbor method, you also lose any prior year’s carryover.

An added wrinkle: If you switch later to the old deduction method, you must account for the prior depreciation although only as basis for depreciation. That means, according to the IRS, you multiply the cost or other basis of the property by the percentage of business/investment use and then subtract any credits and deductions allocable to the property.

Rather than simplify, this complicates the depreciation calculation: You must skip the years when depreciation isn’t charged to determine basis for the current year, but account for those years when determining which year’s depreciation to deduct.

Finally, once you’ve filed with one choice, you cannot amend the return to change the method of deduction. If you have more than one home and you intend to take the home office deduction for offices in each home, you are also limited to using the safe harbor for only one of the offices in any one year.

You’re not required to use the safe harbor rule for any of the offices – a choice some will clearly make despite this IRS stab at simplification.

— By Jim Blankenship, an an independent, fee-only financial planner at Blankenship Financial Planning in New Berlin, Ill., and author of An IRA Owner’s Manual and A Social Security Owner’s Manual. His blog is Getting Your Financial Ducks In A Row, where he writes regularly about taxes, retirement savings and Social Security.

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