IRS has revised Publication 587, Business use of Your Home, for use in preparing 2013 returns. The revised publication clarifies important aspects of the new optional safe harbor method of computing deductions for business use of a home, including a new, comprehensive simplified deduction worksheet.
Click here for Publication 587, Business use of Your Home, revised for use in preparing 2013 returns.
Background. The general rule under Code Sec. 280A(a) is that no deduction is allowed for the business use of a dwelling unit that’s also used by the taxpayer as a residence during the tax year. But under exceptions, if strict requirements are met, deductions are allowed for direct expenses and the business-use part of the indirect expenses relating to business use of a residence:
- Home office expenses are deductible if part of the home is used regularly and exclusively as (1) a principal place of business, or (2) a place to meet or deal with customers or clients in the ordinary course of business. Taxpayers who are employees must meet an additional test – their use of the home office must be for the convenience of the employer. (Code Sec. 280A(c)(1))
- Expenses that are allocable to space within the dwelling unit used on a regular basis for the storage of inventory or product samples held for use in the taxpayer’s trade or business of selling products at retail or wholesale are deductible if the dwelling unit is the sole fixed location of the trade or business. (Code Sec. 280A(c)(2))
- Expenses that are attributable to the rental of the dwelling unit or a part of the unit are deductible. (Code Sec. 280A(c)(3))
- Expenses that are allocable to the part of the dwelling unit used on a regular basis in the taxpayer’s trade or business of providing day care for children, for individuals who have attained age 65, or for individuals who are physically or mentally incapable of caring for themselves are deductible. (Code Sec. 280A(c)(4))
These deductions are limited to the activity’s gross income reduced by all other deductible expenses that are allowable regardless of qualified use (e.g., mortgage interest, real estate taxes, and casualty losses) and by the business deductions that aren’t allocable to the use of the home itself (e.g., expenses of advertising, wages, and supplies). Expenses disallowed solely because they exceed business income can be carried forward, subject to the gross income limitation in the later year. (Code Sec. 280A(c)(5))
Under the general rule, subject to the Code Sec. 280A(c)(5) rule, indirect expenses such as insurance, utilities, and general repairs, plus depreciation, are deductible based on the percentage of the home used for business. Business percentage can be determined by any reasonable method. The most commonly used methods are: dividing the area used for business by the home’s total area; or, if the rooms are about the same size, the number of rooms used for business divided by the total number of rooms in the home.
New safe harbor. To reduce the administrative, recordkeeping, and compliance burdens of determining the allowable deduction for the qualified business use of a residence under Code Sec. 280A, Rev Proc 2013-13 provides a safe harbor method under which an individual determines his allowable deduction for the qualified business use of a home by multiplying a prescribed rate ($5) by the square footage of the part of his residence that is used for business purposes, not to exceed 300 square feet, for a maximum deduction of $1,500. The safe harbor is effective for tax years beginning on or after Jan. 1, 2013. “Qualified business use” for this purpose is a business use that satisfies the requirements of Code Sec. 280A(c)(1) through Code Sec. 280A(c)(4).
The safe harbor method doesn’t apply to an employee with a home office if he receives advances, allowances, or reimbursements for expenses related to the qualified business use of the employee’s home under a reimbursement or other expense allowance arrangement with his employer. (Rev Proc 2013-13, Sec. 4.01(4))
The safe harbor is an alternative to deducting actual expenses. Thus, if it’s used for a tax year, the taxpayer generally can’t deduct any actual expenses related to the qualified business use of that home for that tax year, with the following exceptions:
- Otherwise allowable home-related deductions. A taxpayer who itemizes deductions and uses the safe harbor may deduct any allowable expenses related to the home that are deductible without regard to whether there was a qualified business use of the home for that tax year (e.g., deductions for qualified residence interest, property taxes, and casualty losses). Taxpayers using the safe harbor method deduct these expenses as itemized deductions on Form 1040, Schedule A, and cannot deduct any part of these expenses from the gross income derived from the qualified business use of the home – either for purposes of determining the net income derived from the business or for purposes of determining the gross income limitation under Rev Proc 2013-13, Sec. 4.08(2) (which parallels the gross income limitation under Code Sec. 280A(c)(5)).
- Business deductions unrelated to qualified home use. A taxpayer using the safe harbor method for a tax year may deduct any allowable trade or business expenses unrelated to the qualified business use of the home for that tax year (e.g., expenses for advertising, wages, and supplies). (Rev Proc 2013-13, Sec. 4.05)
A taxpayer using the safe harbor for a tax year can’t deduct any depreciation or Code Sec. 179 expensing for the part of his home that is used in a qualified business use for that tax year. (Rev Proc 2013-13, Sec. 4.06) If he calculates and substantiates actual Code Sec. 280A expenses for a later year, he must calculate the depreciation deduction by using the appropriate optional depreciation table applicable for the property in the manner described in Rev Proc 2013-13, Sec. 4.07(2), regardless of whether he used an optional depreciation table for the property in its placed-in-service year. (Rev Proc 2013-13, Sec. 4.07)
A taxpayer using the safe harbor method for a tax year can’t deduct any disallowed amount under Code Sec. 280A(c)(5) carried over from a prior tax year during which the taxpayer calculated and substantiated actual Code Sec. 280A expenses. He can deduct the carried-over amount in the next succeeding tax year in which he calculates and substantiates actual Code Sec. 280A expenses. (Rev Proc 2013-13, Sec. 4.08(3))
Electing the safe harbor. A taxpayer irrevocably elects the safe harbor by using the method to compute the deduction for the qualified business use of a home on his timely filed, original federal income tax return for the tax year. A change from using the safe harbor method in one year to actual expenses in a succeeding tax year (or vice-versa) isn’t a change in accounting methods. (Rev Proc 2013-13, Sec. 4.03)
IRS’s newly revised Publication 587 provides the following insights on using the safe harbor method to deduct home office deductions.
Shared use. Taxpayers sharing a home (for example, roommates or spouses, regardless of filing status), if otherwise eligible, may each use the safe harbor method, but not for a qualified business use of the same portion of the home. For example, a husband and wife, if otherwise eligible and regardless of filing status, may each use the safe harbor method for a qualified business use of the same home for up to 300 square feet of different portions of the home.
If the qualified business use of the home is also a qualified joint venture, the taxpayer and his spouse figure the deduction for the business use separately, by splitting the actual area used in conducting business between the spouses in the same manner they split your other tax attributes. Then, each spouse figures the allowable area separately. (Where each spouse materially participates as the only members of a jointly owned and operated business and they file a joint return for the tax year, an election can be made to be treated as a qualified joint venture instead of a partnership. This election, in most cases, won’t increase the total tax owed on the joint return, but it does give each spouse credit for social security earnings on which retirement benefits are based and for Medicare coverage.)
More than one qualified business use. If a taxpayer conducts more than one qualifying business in his home, the election to use the simplified method applies to all qualified business uses of that home. However, the taxpayer still is limited to a maximum of 300 square feet for all of the businesses.
More than one home . If the taxpayer used more than one home for business during the year (for example, he moved during the year), the election to use the simplified method may be made for only one of the homes. Deductions for the other home(s) are based on actual expenses.
Part-year use or area changes. If qualified business use was for a portion of the tax year (e.g., a seasonal business or a business that begins during the tax year) or the taxpayer changed the square footage of the qualified business use, the simplified deduction is limited to the average monthly allowable square footage. Calculate the average monthly allowable square footage by adding the amount of allowable square feet used in each month and dividing the sum by 12. But when determining the average monthly allowable square footage, the taxpayer cannot take more than 300 square feet into account for any one month. And qualified business use of less than 15 days in a month doesn’t count at all.
Calculating the deduction under the elective simplified method. To figure the deduction for each qualified separate business use of a home:
- 1. Multiply the allowable area by $5 (or less than $5 if the qualified business use is for daycare that uses space in the home on a regular, but not exclusive, basis).
- 2. Subtract the expenses from the business that are not related to the use of the home (e.g., cost of phone, supplies, professional fees, advertising, depreciation on equipment) from the gross income related to the business use of the home. If these expenses are greater than the gross income from the business use of the home, then the taxpayer cannot take a deduction for this business use of the home.
- 3. Take the smaller of the amounts from (1) and (2). This is the amount that the taxpayer can deduct for this qualified business use of his home using the simplified method.
Publication 587 carries a Simplified Method Worksheet, at pages 29 and 30, for use by employees or partners, or taxpayers that use their home in their farming business and file Schedule F (Form 1040). Taxpayers that use their homes in a trade or business and file Schedule C (Form 1040) use the Simplified Method Worksheet in the Instructions for Schedule C to figure the deduction.