Effective for tax years beginning in 2013, taxpayers can elect a simplified deduction for the business use of their home. The deduction is $5 per square foot with a maximum square footage of 300. Thus, the maximum deduction is $1,500 per year. Here are the details of this simplified method:
- Annual election – A taxpayer may elect the safe-harbor method or the regular Sec 208A method on an annual basis. Thus, a taxpayer may freely switch between the methods each year. The election is made by choosing the method on a timely filed original return and is irrevocable for that year.
- Depreciation – When the taxpayer elects the safe-harbor method, no depreciation deduction (including additional first year or Sec 179) for the home is allowed and the depreciation for the year is deemed to be zero.
- Additional office expenses — Additional office expenses such as utilities, insurance, office maintenance, etc., are not allowed when the safe-harbor method is used.
- Home interest and taxes — Prorated home interest and taxes are not allowed as an office expense when using the safe-harbor method. Instead, 100 percent of the home interest and taxes are deductible as usual on Schedule A.
- Deduction limited by business income — As is the case with the regular Sec 208A method, under the safe-harbor method, the home office deduction is limited by the business income. For the safe-harbor method, the deduction cannot exceed the gross income derived from the qualified business use of the home for the tax year reduced by the business deductions (deductions unrelated to the qualified business use of a home). However, unlike the regular method, any amount in excess of this gross income limitation is disallowed and may not be carried over and claimed as a deduction in any other taxable year.
For example, a taxpayer begins using 400 square feet of her home for business on July 20, 2013, and continues using the space as a home office through the end of the year. Her average monthly allowable square footage for 2013 is 125 square feet (300 x 5 months = 1,500/12 = 125).
Several limitations and restrictions apply. Some of the limitations are when multiple businesses occupy the property or mixed-use of property . Furthermore, depreciation methods should be weighed and considered using the following factors:
- There is no reduction in the basis for depreciation or depreciation recapture when using the safe-harbor method.
- When using the regular method, the income limitation takes into account home interest, taxes and other expenses before allowing the depreciation portion of the deduction. That is not true for the safe-harbor method since the interest, taxes and other business-use-area related expenses are not considered.
The IRS has not yet released a form for this new method. See full discussion at irs.gov, Revenue Ruling 2013-13.
Chris Torchiana is the owner of Main Street Tax Advisory of Northern California, LLC, a full-service tax preparation provider in El Dorado Hills. For more information visit taxplanningguy.com or call 916-934-0452 or 1-888-856-6696.