Home-Office Deductions Made Simple

Friday, October 11 2013

One of the benefits of being freelance, or telecommuting, is being able to deduct expenses from your home-office. But are you writing-off all you can? What exactly is the new "safe-harbor" rule?

October is the ideal time to meet with your accountant to start preparing your year-end taxes. If you've already filed your September 16th quarterly tax deadline, now that it's fresh in your mind, set yourself up for a hassle-free 4th quarter.

Definition: A home office is the place where you regularly and primarily do business; the area designated as your home-office must be used exclusively for that purpose.

In order to benefit from deductions related to your home-office it must satisfy 3 conditions:

  1. The home-office is a space that is exclusively used for your work. You must be able to prove that the part of your home you use as your home office--which can be just a portion of a room as opposed to an entire room--is used only for business. Two exceptions are if you're storing inventory or using a room to provide day care; then you can also deduct the use of the space as part of your residence. Take a picture to document your designated home-office area.
  2. Most of your taxable business income must come from activities in your home office. You must be able to show on your tax return that your home office is your principal place of doing business or that you spend more time working in your home office than anywhere else. Keep records of your activities at your home office and a log of the time you spend working at your home office.
  3. Your home-office must be the place where you meet with clients, patients or customers on a normal basis. It can be where you do most of your paperwork and phone calls (thereby justifying deducting your phone bill); your base of operations. It may or may not be physically attached to the taxpayer's residence; it may be a separate structure on the property used exclusively as a home office.
What if I am an employee working from home?

If you are an employee and work from home the rules are slightly different, but you may still able to qualify for deductions if you meet the above conditions plus the following additional tests:

  • Your business use must be for the convenience of your employer, and
  • You must not rent any part of your home to your employer and use the rented portion to perform services as an employee for that employer.

If you work from home just because it's helpful or convenient, you can not deduct home office expenses. 

Home Office Deductions FAQ 
What is deductible?

Any expense that is exclusively associated with your work is deductable.
There are direct expenses such as materials and infrastructure and Indirect expenses such as utilities and insurance.

 Direct ExpensesIndirect Expenses Not deductable 
  • Materials: computer, phone, software, hardware
  • Office Supplies (paper, pens, folders).
  • Furniture: desk, lamps, shelves, chairs
  • Cleaning services for home-office space
  • Phone bill for business line
  • Mileage ($0.50/mile)
  • Percentage of Rent/Home Loan
  • Maintenance (repairs, upgrades)
  • Cleaning Costs (labor, supplies)
  • Real Estate Taxes
  • Insurance
  • Utility costs
  • Depreciation*
  • Expenses associated with running the home**
  • Other pro-rated expenses
  • Dog walking services or animal hotels.
  • Lawn care or housekeeping for the rest of the house.
  • Re-painting your bedroom 
  • Personal expenses like pedicures or shoes
  • Printing pictures for those frames decorating your office

*Not applicable under the new Safe Harbour optionhome-office-checklist
** Partially deductible

How do I calculate the deduction?
Deductions are based on the business percentage that your home-office occupies in your home. This percentage is then applied to many of the indirect expenses you incur.

To find the business percentage, compare the size of the part of your home that you use for business to your whole house. You can use any reasonable method to determine the business percentage. The following are two commonly used methods for figuring the percentage.

  1. Divide the area (length multiplied by the width) used for business by the total area of your home.
  2. If the rooms in your home are all about the same size, you can divide the number of rooms used for business by the total number of rooms in your home.

Use the resulting percentage to figure the business part of the expenses for operating your entire home.

 Example 1  Example 2
  • Your office is 240 square feet (12 feet × 20 feet)
  • Your home is 1,200 square feet
  • Your office is 20% (240 ÷ 1,200) of the total area of your home
  • Your business percentage is 20%
  •  You use one room in your home for business
  • Your home has 10 rooms, all about equal size
  • Your office is 10% (1 ÷ 10) of the total area of your home
  • Your business percentage is 10%
What is the simplified "Safe Harbor" option?

In order to simplify the process, IRS announced Code 280A, a new short-cut or "safe harbor" rule earlier this year. The criteria necessary to be deemed as a qualified home office must have already been satisfied with the IRS in order to opt for the "safe harbor" method.

How is the Simplified Option different from the regular one?
The biggest difference with the new Save Haven option is that it simplifies the way you calculate the value of your home-office by setting a rate of $5/square foot, up to 300 square feet (maximum write-off of $1,500). It also eliminates the need to distinguish between the expenses for personal use and business use.
You won't be able to depreciate the part of your home used for business, though, if you go this route. If your write-offs exceed $1,500 or your home office is bigger than 300 square feet, you can still claim your home-office deductions based on actual expenses. In general, if the square footage of your home office equals 10 percent of your home's, you can claim 10 percent of these expenses.

 Simplified Option  Regular Method
Deduction for home office use of a portion of a residence allowed only if that portion is exclusively used on a regular basis for business purposes (SAME) Deduction for home office use of a portion of a residence allowed only if that portion is exclusively used on a regular basis for business purposes
Allowable square footage of home use for business (not to exceed 300 square feet) Percentage of home used for business

Standard $5 per square foot used to determine home business deduction Actual expenses determined and records maintained 
Home-related itemized deductions claimed in full on Schedule A 

Home-related itemized deductions apportioned between schedule A and business schedule (Sch. C or Sch. F) 
No depreciation deduction

Depreciation deduction for portion of home used for business
No recapture of depreciation upon sale of home Recapture of depreciation on gain upon sale of home
Deduction cannot exceed gross income from business use of home less business expenses (SAME) Deduction cannot exceed gross income from business use of home less business expenses
Amount in excess of gross income limitation may not be carried over Amount in excess of gross income limitation may be carried over
Loss carryover from use of regular method in prior year may not be claimed

Loss carryover from use of regular method in prior year may be claimed if gross income test is met in current year

Safe Harbor Method Limitations

As can be expected, the IRS has placed a few limitations on the "safe harbor" method deduction:

  • The deduction is limited to $1,500 per year, meaning that your home office space should not exceed 300 square feet; the exception to this, however, is dependent upon how many qualified home offices are under the same roof.
  • The option chosen, whether the "safe harbor" method or the conventional (actual expenses) method must be consistently applied to all the Taxpayers' qualified businesses.
  • Taxpayers who share a home, regardless of filing status, may each claim the safe harbor deduction provided they have separate and distinct home office areas.
  • Taxpayers who have more than one qualified home office, i.e. in more than one home, may use the safe harbor method for only one home office space.
  • A taxpayer cannot opt for the safe harbor method if he or she derives rental income from the same home as the qualified business use.
  • The safe harbor method is not applicable for those Taxpayers reimbursed by an employer for home office related expenses.

The "safe harbor method" is optional according to the IRS, and taxpayers might want to evaluate now whether they will opt for this method or the conventional one as they begin their tax planning preparations for 2013. While a tedious and mind-numbing exercise, in the end it may be financially beneficial to tally up all of those numerous invoices, expense reports and receipts and go with the conventional method.

What forms do I have to file?
Form 8829: Expenses for Business Use of Your Home
Home office rules are available in IRS Publication 587.

When do I file?
Payment Period Due Date
January 1 - March 31, 2013 April 15, 2013
April 1 - May 31, 2013 June 17, 2013 
June 1 - August 31, 2013 September 16, 2013 
September 1 - December 31, 2013 January 15, 2014

It's strongly recommended to file quarterly (Independent Contractors are required to pay throughout the year).

Independent contractors who are paid only for work performed, in general, must pay federal taxes on income and FICA. You will need to pay estimated taxes throughout the year instead of once a year on April 15th. Go to IRS resources to help you understand how to pay federal taxes as an independent contractor: Self-Employed Individual Tax Center. Depending on the location of your business, you may be required to file state and local income and business taxes.

What should I be asking my accountant?
Start planning early. Your tax time accountant meeting should take place no later than October of any given tax year. Here are some things to keep in mind:

  1. See if you can deduct the full purchase price of new assets rather than deducting their depreciation over the years.
  2. Find out if your health insurance premiums are deductible.
  3. Figure out your business mileage. Each mile scores you a deduction of 50 cents.
  4. Set up a payment plan early. If you find yourself unable to pay the tax you owe in April, the IRS will work with you.
  5. Send out those 1099s already! The deadline has passed for issuing 1099s to employees who worked for you on a contractual basis and earned more than $600.
  6. See your accountant throughout the year. Keep her/him in the loop about profit increases, which could warrant higher estimated tax payments, or expenses that could qualify for deductions of which you are unaware.
  7. Avoid paying business expenses with cash. Otherwise there's no paper trail and you won't be able to prove your business expenses. Use a separate business credit card to track purchases.

The IRS has produced very practical and complete guides to filing for home office deductions, consult them!
(See the IRS Publication Guide 587)

Here is a helpful video the IRS explaining home-office deductions:

Always consult your tax professional for specific tax advice regarding your particular situation.

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