If you use part of your home for business, you may be able to deduct expenses for the business use of your home. The home office deduction is available for homeowners and renters, and applies to all types of homes. A legitimate home office can turn many nondeductible personal expenses into tax deductions.

As you complete your extended tax returns, the pain of gathering or reviewing documentation for substantiating your home office tax deduction once again becomes fresh. With home office use soaring and millions of taxpayers claiming a business use of the home tax deduction in the last few years, the Internal Revenue Service (IRS) recently announced a simplified method for claiming a home office deduction. This new optional method reduces recordkeeping burdens and will likely save taxpayers hours of data gathering, according to the IRS. But, will the new method result in greater tax savings?

Many have their doubts about this.

The new optional method allows taxpayers to claim a prescribed measly rate of $5 per square foot of home office space, up to a maximum of 300 square feet—or $1,500 per year beginning with the 2013 tax year. While under the new optional method many taxpayers will be able to save some time by skipping some of the tedious and complex calculations currently required to claim the home office deduction, many will realize less tax savings.

Additionally, a taxpayer who elects the simplified method may not deduct any disallowed expenses carried over from a prior taxable year during which the taxpayer calculated and substantiated actual expenses under the conventional actual method. However, direct business expenses unrelated to the home, such as advertising, supplies, commissions, fees and wages paid to employees, are still fully deductible.

A taxpayer may elect annually whether to use the simplified or conventional actual method and may switch between methods from year to year. However, once a return is filed, it may not be amended to change the method of reporting. Additionally, depreciation is no longer deductible under the simplified method, and switching between the two methods from year to year will result in a complex calculation of gain—including depreciation recapture—if and when the home is eventually sold.

The use of the actual expense method still requires adequate substantiation of expenses, and there are no changes to the current exclusive and regular use requirement, under either method. That is, you have to regularly use part of your home exclusively for conducting business, either as your principal place of business or as the place for meeting patients, clients or customers. For example, if you use an extra room to operate your business, you may claim a home office deduction for that extra room. If you use a section of your kitchen for business purposes, you are not eligible to claim the deduction.

Is the new simplified method for you? Taxpayers with incomplete records and/or taxpayers with primarily mortgage interest and real estate taxes expenses are most likely to benefit from this new method. Taxpayers utilizing a large amount of space and/or incurring significant home expenses will likely benefit from use of the conventional actual method.

As the rules are complex and the home office deduction creates higher audit risk, proper planning is essential to optimizing the tax benefit of your home office expenses and to potentially avoid running afoul of IRS requirements. To determine which option is best, it may be worthwhile to crunch the numbers.

For Further Information

If you would like more information about this topic or your own unique situation, please contact Steven M. Packer in the Tax Accounting Group or the practitioner with whom you are regularly in contact.

As required by United States Treasury Regulations, the reader should be aware that this communication is not intended by the sender to be used, and it cannot be used, for the purpose of avoiding penalties under United States federal tax laws.

Disclaimer: This Alert has been prepared and published for informational purposes only and is not offered, nor should be construed, as legal advice. For more information, please see the firm's full disclaimer.