One potential business deduction you do not want to overlook is the home office deduction. Almost anyone with a full or part-time business who uses a portion of his or her home exclusively for that business can qualify for this deduction.
Even though they qualify for the home office deduction, many people don't take it because it can be complicated or they fear it will increase their chances of getting audited. There is no empirical evidence that taking this deduction increases your chances of being audited.
Moreover, for years, the IRS has denied that the home office deduction is an audit flag. In fact, the IRS has created an optional simplified version of the deduction in an attempt to encourage people to take it. The new simplified home office deduction was announced by the IRS in 2012 but it can only be used for 2013 and future tax years. So this is the first tax filing season when it is available.
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. Because of this dollar cap limitation, it should 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. Nor do you have to complete Form IRS Form 8829, Expenses for Business Use of Your Home. For details, see “IRS Creates Simplified Home Office Deduction.”
The IRS has provided some additional insights on the simplified method in its newly revised Publication 587, Business Use of Your Home.
If you share your home with someone else—for example, you have a spouse or roommate—you may each use the simplified method if you are otherwise eligible to do so. However, you and the other person may not use the same square footage in the home to figure your deductions. Instead, you must allocate the shared space between yourselves in a reasonable manner.
Example: Kathy and Haley are roommates. Kathy has a consulting business, while Haley has a separate freelance writing business. Kathy separately uses 200 square feet of the home for her business; Haley exclusively uses 100 square feet for her business. Together, they share an additional 100 square feet of the home for their businesses. In addition to the portions that they do not share, Kathy and Haley can both claim 50 of the 100 square feet or divide the 100 square feet between them in any other reasonable manner. If divided evenly, Kathy could claim 250 square feet using the simplified method and Haley could claim 150 square feet.
If you have more than one business in your home that qualifies for the home office deduction, your election to use the simplified method applies to all your qualified business uses of that home. However, your total deduction still is limited to a maximum of 300 square feet for all of your businesses.
If you used more than one home for business during the year (for example, you moved during the year), you may use the simplified method for one of the homes. It’s up to you to decide which one to use. Your home office deductions for the other home or homes must be calculated using the actual expense method.
If you used your home office for only a portion of the tax year, or you changed the square footage of your office during the year, you must calculate the average monthly square footage of the office for the year. To do this, add the amount of square feet used each month and divide the total by 12. But you cannot take more than 300 square feet into account for any one month. Business use of less than 15 days in a month doesn't count at all.
Example: On April 20, 2013, Amy began using 100 square feet of her home as the office for her mobile app development business. On August 5, she expanded the office to 330 square feet and continued to use it through the end of the year. Her average monthly allowable square footage for 2013 is 150 square feet. This is figured using 100 square feet for May through July and 300 square feet for August through December divided by 12 months in 2013 ((0 + 0 + 0 + 0 + 100 + 100 +100 + 300 + 300 + 300 + 300 + 300)/12).