IRS simplifies guidelines for deducting home office

There was a time, not long ago, when working at home and taking a home office deduction on a federal income tax return raised a huge red flag for IRS auditors. That’s because the space being used as the “office” was a kitchen table or a comfy couch in the den.

The IRS quickly narrowed that loophole and issued more specific guidelines, stating the space had to be used exclusively and on a regular basis for either the entire business or its administrative and management activities.

Now, in a move to make the deduction easier for taxpayers, the IRS is offering a new optional deduction, capped at $1,500 per year based on $5 a square foot for up to 300 square feet. The new option will be available on 2013 returns that most taxpayers will file in early 2014.

“This is a common-sense rule to provide taxpayers an easier way to calculate and claim the home office deduction,” said Steven T. Miller, acting IRS commissioner.

Why is Uncle Sam doing this now? There’s a notion among accountants that the rules are now too complex for the nearly 3.4 million taxpayers who claimed deductions for business use of a home.

In addition, there has been grumblings about the amount of tax due when the home is sold because of depreciation recapture. According to Rob Keasal with the accounting firm of Peterson Sullivan, the new option would not include depreciation and its subsequent recapture tax.

A home office deduction is comprised mainly of depreciation, utilities and insurance. For example, if a home has 2,500 square feet and the old den used as the office is 250 square feet, then 10 percent of the utilities and insurance are deductible.

The actual office depreciation is 10 percent of what would be a depreciation deduction if the entire home were being depreciated for tax purposes. (Depreciation is not allowed on a typical principal residence, so the square footage allotted to “residence” would not qualify.) Supplies and other expenses directly related to the home office are fully deductible.

To help with the process, the Internal Revenue Service’s Publication 587 “Business Use of Your Home” is accessible on the Internet at http://www.ustreas.gov.

Under the present “ordinary” method, if you sell your home at a gain, any depreciation for a home office taken after May 6, 1997, will have to be “recaptured.’’ That means that any profit on the business portion is taxable as capital gain.

In a capsule, if you bought your home for $150,000 and sold it for a net figure of $300,000, your capital gain would amount to $150,000. Because the business portion does not escape the new primary residence exclusions, 10 percent, or $15,000 (the 250 square feet of office space) would be taxable.

One way some taxpayers have been avoiding the home office tax is eliminating their home business use two years before selling the home. If you can find another place to work, you could revert the usage back to a 100 percent primary residence.

According to the IRS, the new option provides eligible taxpayers an easier path to claiming the home office deduction. Currently, they are generally required to fill out a 43-line form (Form 8829) often with complex calculations of allocated expenses, depreciation and carryovers of unused deductions.  Taxpayers claiming the optional deduction will complete a significantly simplified form.

Homes that can accommodate an office – perhaps converting an extra bedroom or garage – are becoming as desirable a selling point as any other home amenity. That’s because when potential home buyers intend to make a living from a specific space within the new home, they choose a home that meets both their living and working requirements.

While resale homes often have to be remodeled to include home-office space, many designers are helping builders with new plans that include one room that’s versatile and can be easily identified as a home office. Some real estate agents say a home office space has helped to make or break a sale in a relocation situation, especially for families with double incomes.

Remember, the new option becomes available on 2013 returns. If you sold your home for a gain in 2012 and claimed depreciation for a home office last year, you face a tax liability on the depreciation recapture.