06 Jun Tax Deduction When Using Home As Office
Would you like to enjoy the tax benefits of using a space in your home as your office? You’ll learn here a lot of things in determining the tax deduction for home office, which will help you address the tax issues with the IRS.
Let’s examine the parts of your home that can be used for your business operation before going deeper into the other important details.
- Total area used regularly and exclusively for your business (this can be for the inventory of your product samples)
- Total area of your home or residence
- Total number of hours you use for business in the entire year
- ·Daycare facilities not used for your business
To figure out the allowable tax deduction for home office, you have to use Schedule C, line 29. Enter the amount including the gains derived from your home office. Then, you have to deduct the losses from your business operation. The casualty losses, deductible mortgage interest, and real estate taxes will also be included in the computation. Other important aspects include insurance, rental fees, repairs and maintenance, utilities, and other expenses.
What if the value of your home office is depreciating? Will it affect the deduction process? Yes! Just enter the smaller amount of your home’s adjusted market value the time you’re doing the computation. The value of the land where the house is erected will also be computed. You can determine the depreciation percentage. But it is advised that you ask the help of a professional for you to ensure that the adjusted taxes you’ll be paying to the IRS are accurate.
What about the carryover of disallowed expenses for the current year? In this case, you will use the operating expenses as well as the excess casualty losses and depreciation value.
The main basis when calculating the tax deduction for a home office is the actual costing method or the simplified method that the IRS has just recently used. Each of these two methods, of course, has pros and cons.
For every taxpayer, there’s a need to analyze the figures using the home office’s square footage. Furthermore, it is important that the cost of the home and marginal tax rate of the taxpayer are figured out. This is just a simple thought given in order to get the right percentage of the business’ tax when the home is used as an office. When the figures increase, then the benefits of the simplified method tends to decrease.
The business individuals working at home can deduct business expenses during tax computation. This is when the part of your home is determined and intended for office use. When you’re using such home area as regular office space, then it’s definitely beneficial for you. The exclusive use of such area implies that the space is used for business purposes. In other words, you’re performing your business transactions and activities in this particular space of your home.
How about the employees working at the convenience of their home? If a particular employee works at home, such deduction is not permitted. This is one of the limitations of the IRS provision. It’s so because the provision says that the tax deduction is only intended for trading or business activities, not for home-based employment.
Since the fiscal year 2013, the Internal Revenue Service is giving an alternative to taxpayers. This is known as the “safe-harbor alternative,” wherein the taxpayers can claim home office deduction. In the past, there’s a complex way to compute based on the burdensome records being kept by the business owners. But such safe-harbor method provides the simplest way. How is the computation done? Easy! You only need to multiply the total square footage of the part of your home used for office by $5.
So easy, isn’t it? However, you have to evaluate the costs and benefits of using this simple method, because there are moments where the complex method is more applicable than the simple one.
Comparing the Two Methods
- Actual-Cost Deduction Method
We will set an example here for you to understand it clearly. You have a net income from your business before the tax deduction of $5,600 is computed. You bought a home with the amount of $1,000,000 (land value is inclusive) and you have a space of 350 sq. feet used for office. Let’s say this is 10% of the total area of your home which is 3,500 sq. feet. The marginal tax rate, in this case, is 15%. You paid other dues such as $10,000 for mortgage interest and another $3,000 as the real estate tax. There are indirect expenses such as utilities, repairs, and maintenance, as well as insurance. The total indirect costs total $4,800. You have a depreciation value of $256.
Using the Actual-Cost Deduction Method, here are the three main components, as defined in Sec. 280A(c)(5).
- Tier I Deductions: How is it computed? This includes the interest and real estate taxes on your home. In our example, the total amount is $1,300.
- Tier II Deductions: The expenses used as a basis are the insurance, utilities, and repairs and maintenance. The amounts you’ll use for these expenses can be deducted in full. But it can only be done when it’s relevant to the business portion of your home. We have an example here. The total is $4,800.
- Tier III Deductions: The depreciation value allowed on the business portion of your residential building is actually 39 years in longevity. Then, the depreciation value computed is amounting to $256.
There’s a limitation when using the simplified safe-harbor method. The total space to be used is up to 300 square feet only being the maximum allowable space. You need to multiply it by $5 per square foot.
The safe-harbor method is used on behalf of the three tiers explained above (Tier I, II and III Deductions). The other bases or parameters such as the interest and taxes are already deducted on Schedule A according to the itemized deductions
According to the above-cited explanations, you can have a net savings of $115. This figure comes out based on the supplementary deductions under the simplified safe-harbor method. The exact figure would be $764, multiply it by 15%. To say the least, however, it’s still significant to look for its accuracy, which can only be done when the total tax savings are evaluated based on the following considerations:
It is important to compute both the taxpayer’s regular income tax and self-employment tax using each method cited above. The interest and taxes allowed are deducted on Schedule A, not on Schedule C. But this can offset together with the income tax savings based on the two deductions being set.
The cost of the allowable tax based on depreciation should also be evaluated and determined. The third tier deduction for depreciation can become a taxable gain. This will happen exactly when the home is sold to a buyer. The limitations being set are $250,000 for a single taxpayer and $500,000 for a couple taxpayers filing in a joint manner. But there is still a tax at 25% to be collected from the depreciation of the home value.
Now, the simplified method can possibly increase the taxpayer’s adjusted gross income otherwise known as AGI. This can directly impact the deductions and other computations according to AGI.
Let’s now take a look at the advantages and disadvantages of Safe-Harbor Method.
- It is easy to use for home office deductions.
- It stops the burden attached to taxpayer’s recordkeeping.
- The amounts used are for the home office and are deductible on Schedule A.
- The increase in self-employment earnings can lead to higher Social Security benefits.
- The shift from the actual-cost method to safe harbor cannot be used as a change in accounting.
- Tax return preparation costs are deductible but only if the charge changes with the schedules being set.
- The depreciation taken every year is at $0-basis and is reduced only when the actual costs are computed.
- It increases self-employment taxes.
- If there’s a loss, it can’t be carried over to the subsequent year.
- The safe-harbor method is year-by-year, but is irrevocable and cannot be amended.
- The increase in AGI reduces particular deductions.
In our examples above, the taxpayers can benefit from the tax deductions when a part of your residential building is used for business purpose. But with regard to which method is more appropriate than the other, the clear understanding to each method presented and explicated is the main point of reference. Meaning, you have to understand the main emphasis of each method. You have to understand that the IRS is always eager to collect taxes.
You have to be reminded that even if you use the simple safe-harbor method, it cannot be translated to a larger monetary gain. In other words, it cannot trigger more additional tax savings. You can save a hundred bucks by using this method but only if it’s applicable to your situation. Always remember that you cannot use the safe-harbor method if the cost of your home is increasing because the value of your marginal tax rate will also increase dramatically.
For the self-employed taxpayers, the increase in self-employment taxes is a big factor causing the decrease in income tax savings. This is when you use the simplified method of deducting taxes. Fortunately, however, the safe-harbor method has an annual election. The implication is that you, being a taxpayer and having a fluctuation in marginal tax rate yearly, can have an optimal alternative or strategy.
When you request for a professional tax consultant, you have to make sure that you can get the right person for the job. If the one preparing your tax return documents charges fees according to the number of schedules, you can save more money by way of omitting Form 8829. But the amount you can save is just minimal. It is important for you to understand that there are other issues the taxpayers have to understand such as the limitations, exemptions, the itemized deductions, as well as the AGI aspect.