The Real Deal New York

IRS streamlines work-from-home deductions

New “safe harbor” option is based on workspace square footage

January 25, 2013 12:30PM
By Kenneth R. Harney

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Home office (Source: Home Office Design Blog)

If you’re one of the millions of homeowners and renters who work or run a business from the place you live, here’s some good news on taxes: The Internal Revenue Service wants to make it easier for you to file for deductions on the business-related use of your home. Rather than the complicated 43-line form you now have to fill out to claim a write-off — the instructions alone take up four pages of text and involve computations ranging from depreciation to utility bill expense allocations — the IRS has come up with a much simpler option: What it calls a “safe harbor” method that allows you to measure the square footage of your business space and apply for a deduction.

The move comes at a time when the use of homes for work is soaring, thanks to technologies such as high-speed Internet and Skype. Last October the Census Bureau estimated that as of 2010, the last year when data were available, 13.4 million Americans were making some type of business use of their homes, and that home businesses employed nearly 10 percent of all workers. During the same year, the IRS says 3.4 million taxpayers filed for the home office deduction. The sheer size of the gap raises the question: Are millions of people declining to seek write-offs for which they’re qualified?

Kristie Arslan, president and CEO of the National Association for the Self-Employed, thinks so. The IRS rules for home offices have been “cumbersome and time consuming,” she said, “… and year after year hard-earned dollars were left on the table.” Otherwise qualified business owners and entrepreneurs were daunted by the record-keeping and paperwork required. They also worried that they could be exposed to an audit by the IRS if they made mistakes in filing.

The new IRS option plan, which will be available for 2013 and beyond, allows owners and employees who work from home to deduct $5 per square foot of home office space per year, up to a maximum allowable space of 300 square feet. The write-off is capped at $1,500 per year, but the hassle factor is negligible.

Here’s how it works. The Internal Revenue Code permits you to deduct expenses for a home office that is used “exclusively” and on a “regular basis” as your principal place of business “for any trade or business,” or as a place to meet with clients or customers. Provided you qualify on these threshold tests, the code allows you to deduct mortgage interest, property taxes, rent, utilities, hazard insurance and other expenses based on the percentage of the total space of the home that is attributable to your business use.

Though this method can produce sizable deductions, critics have long argued that the computations for some of the allowable items — depreciation on the house you own is one — can be tricky and require significant record-keeping and time expenditures to get it exactly right. Plus the IRS has acknowledged that the presence of a home office deduction on a taxpayer’s filing may increase that taxpayer’s potential for being selected for audit.

The new streamlined approach essentially boils everything down to just one measurement: How much square footage that qualifies for business purpose treatment are you using? Multiply that number by $5 per square foot and you’ve got your deduction amount. As long as this does not exceed $1,500, you can use the new short form write-off. If the total is more than $1,500, you can use the more complicated option, which is spelled out in IRS Form 8829 and available at IRS.gov.

The pros and cons of the new option? Abe Schneier, senior technical manager for taxation at the American Institute of Certified Public Accountants, says it should be a money-saver for small-scale enterprises and start-ups. “Anybody who’s going to start a new business working from home will probably find this a great advantage,” he said in an interview.

On the other hand, owners whose operations require large amounts of space and who have sizable utilities, insurance and other expenses probably will want to stick with the traditional method — complicated though it can be — because it can yield them much higher write-offs.

So take a look at how much time you’re spending on business work in your home, review the basic rules outlined in IRS publication 587, “Business Use of Your Home,” and go with the smarter option for your situation.

Kenneth R. Harney is a syndicated real estate columnist.

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