Simplified Rules for Calculating the Home Office Deduction

March 26, 2014

For years, the IRS has maintained a somewhat complicated method for calculating the amount of deductible expenses small business owners and work-from-home employees could claim under the Job Expenses section of Schedule A.  Starting with the 2013 tax return, the IRS now offers a simplified option for calculating this deduction.  This simplified option greatly reduces the complexity of the regular method—which requires completing a lengthy tax form (Form 8829) and making complex calculations of allocated expenses, depreciation, and carryovers of unused deductions—and is expected to save small businesses 1.6 million hours a year in paperwork and recordkeeping.  Instead, taxpayers claiming the simplified option need only complete a short worksheet.  Keep in mind that the simplified option does not change the criteria for who may claim a home office deduction—it just simplifies the calculation and recordkeeping requirements.

Who qualifies for a home office deduction?

Taxpayers claiming this deduction must use the home office regularly and exclusively for work.  Regular use is based on the facts and circumstances of your situation and does not include incidental or occasional business use.  In general, if your employer provides you with a regular place to work and you simply work out of your home for convenience, you cannot claim the deduction (see page 3 of Publication 587).

How are the two options different?

Under the regular method, the value of the deduction is based on actual expenses incurred prorated by the percentage of the home used for business.  For example, a 300 square foot office in a 3,000 square foot home would allow the taxpayer to deduct 10% of mortgage interest, real estate taxes, insurance, utilities, depreciation, and other expenses associated with the maintenance of the home.  Any home-related deductions claimed on Schedule A (e.g. mortgage interest, real estate taxes) must be allocated between personal use and business use (no double-dipping!).  Also, any deduction for depreciation reduces the cost basis in the home and is recaptured upon the sale of the home.

Under the simplified option, a taxpayer may deduct $5 per square foot of home office space, up to 300 square feet, for a maximum deduction of $1,500 per year.  Taxpayers using the new option are not eligible to claim depreciation on the portion of their home used for work, but they can claim allowable mortgage interest, real estate taxes, and casualty losses on the home as itemized deductions on Schedule A.   These deductions do not have to be allocated between personal use and business use. Since no deduction is allowed for depreciation, there is no recapture upon the sale of the home.

Which method is best?

Well, that depends.  The first thing you may want to do is determine if claiming a home office deduction is even worth it.  The value of a home office deduction is only to the extent that the TOTAL value of job-related and certain miscellaneous expenses exceed 2% of your adjusted gross income (AGI).  Also, new tax laws reduce total itemized deductions for certain high-income households.  If your AGI is too high, you may see little or no value in taking a home office deduction no matter which method you use.

Second, if you determine that there is value in taking a home office deduction, then you should consider which option gives you the greatest benefit for the effort involved.  For example, claiming a deduction using the regular method requires filling out more complicated paperwork, keeping good records, and having a higher probability of being audited.  If, after all of that, you only end up with an extra $100 in tax savings, you may decide that it’s not worth the hassle. The new simplified option for home office deduction may not help everyone, but if it helps you then it’s all worth it.