Deducting expenses for your home office just got a lot simpler with the new standard deduction
The home-office deduction can be one of the most valuable deductions for self-employed taxpayers. But according to the National Association for the Self-Employed, only 42% of the organization’s members actually claim the home-office deduction.
The primary reason NASE members cite for forgoing the home-office deduction: complexity. Form 8829, the home-office deduction form, requires you to complete numerous calculations to determine the amount you are allowed deduct. On top of this, irregularities in how you calculate these amounts might increase your chances of getting audited.
But starting this year, claiming the home-office deduction will get much easier thanks to the new standard deduction for home-office expenses. Rather than adding up all of their actual home-office expenses, taxpayers can now take the standard deduction, which is worth $5 per square foot of space that is used for business, up to a maximum of $1,500.
How Does the Home-Office Standard Deduction Work?
For 2013 taxes, which must be filed by April 2014, taxpayers who operate a business out of their home can choose to either a) use the traditional method of itemizing home-office expenses or b) claim the new standard deduction.
In previous years, taxpayers would have to add up all of their allowable home-office expenses (including mortgage interest or rent, property tax, utilities, home-owner’s insurance, repairs, and depreciation) and then multiply that amount by the percentage of the home’s total square footage that is used as a business office.
With the standard deduction, taxpayers simply measure the size of their office and then multiply it by $5 per square foot. The standard deduction is capped at $1,500.
Who is Eligible to Claim the Home-Office Deduction?
The rules for what qualifies as a home office have not changed. To qualify as a home office, the space must be:
- Used exclusively for your business: The office must be a room or space in your house that is used solely as an office. You can’t put a desk in your living room and claim the room as a home office if you use it for work during the day and as a living room at night.
- Used regularly: You must use the room as an office regularly throughout the year. If you didn’t start using the room as an office until part-way through the year, you have to prorate your deduction accordingly. For example, if you convert a spare room into an office on July 1 and then use the room exclusively as an office for the rest of the year, you only get to claim the home-office deduction for half of the year.
- Your principal place of business: You must use the office for things that are central to the operations of your business. The office must be where most or a substantial portion of your business takes place, and you cannot have an office elsewhere.
Which Method Makes Sense For You?
The ease and simplicity of the home-office standard deduction comes with a price for some taxpayers. Because it is capped at $1,500, the standard deduction might be substantially smaller than what a taxpayer could claim by itemizing. According to an article from The New York Times, estimates for the size of the average home-office deduction range from $2,000 (from the NASE) to $3,000 (from the IRS).
For a taxpayer in the 28% marginal tax bracket, a $2,500 home-office deduction would reduce his tax bill by $700. If that taxpayer had instead used the standard deduction for his 300-square foot office, the $1,500 deduction would have reduced his tax bill by $420, or $280 less than he would have saved by itemizing.
For taxpayers who are very well organized and do a great job of tracking expenses throughout the year, that extra $280 might be worth going through the process of itemizing. But for less-organized people, the time and effort of tracking down utility bills and payment stubs for insurance premiums and property tax might not be worth $280.
The calculation is not quite as simple as that, however, for self-employed people who own their homes. In some cases, the home-office standard deduction could actually result in more tax savings than itemizing.
This is because when you itemize, whatever portion of your mortgage interest and property taxes that you claim as a home-office expense reduces the amount that you can claim as a personal deduction on Schedule A. But when you use the home-office standard deduction, you are allowed to deduct the full amount of the interest and taxes on Schedule A.
For example, let’s say John’s home office represents 10% of the total square footage of his home and John’s 2013 mortgage interest totaled $20,000 and his property taxes were $7,000.
If John itemizes his home-office deduction, he’ll claim 10% of his interest ($2,000) and taxes ($700) as a business expense. The remainder of his interest ($18,000) and taxes ($6,300) would be claimed as a personal expense on Schedule A.
But if John chooses the home-office standard deduction, then he won’t claim any of his interest and taxes as a business expense, and he’d deduct the full $20,000 in interest and $7,000 in taxes as personal expenses on Schedule A.
Put the Home-Office Deduction to Use
Regardless of whether you use the new standard deduction or the traditional itemizing method, the home-office deduction can deliver significant tax savings for self-employed taxpayers. At Eilts & Associates, we will help you figure out what expenses you are able to deduct for your home office and determine which deduction method makes the most sense for you.
As you begin preparing to file your 2013 taxes, we are available to help you navigate the decisions about the home office and other valuable business deductions. Contact us (773.525.6171; bart@eiltscpa.com) to discuss your business deductions.
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