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.
This is a valuable tax deduction that should not go overlooked by taxpayers determined to effectively maximize profits and minimize taxes. Taxpayers cannot deduct more than the net business profit. Any unused home office deduction, is carried over to the following year.
There are two basic requirements for your home to qualify as a deduction:
Regular and Exclusive Use
You must regularly use part of your home exclusively for conducting business.
Principal Place of Your Business
You must show that you use your home as your principal place of business. If you conduct business at a location outside of your home, but also use your home substantially and regularly to conduct business, you may qualify for a home office deduction.
Additional tests for employee use. If you are an employee and you use a part of your home for business, you may qualify for a deduction for its business use. You must meet the tests discussed above plus:
Your business use must be for the convenience of your employer, and
You must not rent any part of your home to your employer and use the rented portion to perform services as an employee for that employer.
If the use of the home office is merely appropriate and helpful, you cannot deduct expenses for the business use of your home.
There are two methods that can be used when approaching home office deductions.
For taxable years starting on, or after, January 1, 2013 the simplified option can significantly reduce record-keeping burden by allowing a qualified taxpayer to multiply a prescribed rate by the allowable square footage ($5 per square foot limited to 300 square feet) of the office in lieu of determining actual expenses.
Taxpayers using the regular method instead of the optional method, must determine the actual expenses of their home office. These expenses may include mortgage interest, insurance, utilities, repairs, and depreciation. Generally, when using the regular method, deductions for a home office are based on the percentage of your home devoted to business use.
Depreciation and Recapture
Depreciation taken as part of the regular method to deduct home office expenses provides a larger deduction but is recaptured in later years if taxpayers decide to sell the home.
If the regular method is used to calculate the home office deduction all allowed or allowable depreciation must be considered at the time of sale. For most taxpayers who have a business office, the simplified method is generally preferable when the cost of the residence is $200,000 or less. When the cost of the residence is $300,000 or more, the actual-cost method is preferable. When the cost of the residence is between $200,000 and $300,000, the decision to use the simplified method depends on the marginal tax rate and the business use percentage.
The depreciation will produce a taxable gain if/when the residence is sold, because of the special Sec. 121 recapture rules. Normally, the gain on the sale of a personal residence is tax free provided the gain falls within the allowable exclusion limits but, gains attributable to the accumulated depreciation taken on the residence is taxed at 25% or the taxpayer’s marginal tax rate, if less.
To avoid depreciation recapture taxpayers can utilize the simplified method. Under this option, depreciation is treated as zero and won’t reduce the basis of the home.
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