If you use a home office exclusively for business purposes, you can deduct as a business expenses a portion of the cost of operating your home. However, the home office deduction can be complex. You need to keep good records of your home expenses, allocate the expenses of operating your home between business and the personal uses, and complete a special IRS form, Form 8829. Lots of people who qualify for the deduction don't take it because they don't think it's worth the trouble.
In a rare move to simplify life for taxpayers, the IRS has created a new simplified optional home office deduction. The simplified home office deduction starts this year and can be claimed on your 2013 tax return, which you file in 2014. You can't claim the simplified deduction on your 2012 return, which you must file in 2013.
Using the optional method, you simply deduct $5 for every square foot of your home office. However, the deduction is capped at $1,500 per year; so it can only be used for offices up to 300 square feet.
Using the optional method relieves you from having to keep records of your home office expenses such as utilities, rent, mortgage payments, real estate taxes, or casualty losses. And you don't have to complete Form 8829.
Homeowners using the new option cannot claim a depreciation deduction for their home office. However, they can claim allowable mortgage interest, real estate taxes, and casualty losses on the home as itemized deductions on Schedule A. These deductions need not 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.
It's important to understand that all the regular rules for qualifying for the home office deduction still apply even if you use the optional method. To qualify, you must meet any one of the following requirements:
- your home office is your principal place of business
- you regularly and exclusively use your home office for administrative or management activities for your business and have no other fixed location where you perform such activities
- you meet clients or customers at home
- you use a separate structure on your property exclusively for business purposes
- you store inventory or product samples at home, or
- you run a day care center at home.
If you're an employee, in addition to meeting the above tests, the business of your home must be for the convenience of your employer.
Is it a good idea to use the new simplified home office deduction? Only if the deduction you could obtain using the regular method isn't much more than $1,500. Most people with home offices, particularly those who rent their homes, can qualify for a home office deduction much larger than $1,500. For example, a person with a 100 square foot home office who pays $1,000 per month in rent and utilities would qualify for a $500 deduction using the optional deduction (100 sq. ft. x $5 = $500), and a $1,200 deduction using the regular method (10% x $12,000 = $1,200). The inability to deduct depreciation doesn't make the optonall method so great for homeowners either.
If you're thinking about using the optional method, you should figure your deduction using both methods and use the method that gives you the largest deduction. The regular method does require more recordkeeping than the optional method, but you probably keep these type of records anyway. Doing the required calculations and filling out the form can be challenging, but will be much easier if you use tax preparation software.