Home offices have become a much ‘safer harbor’

A longtime friend who retired from a corporate job and is now selling second homes was concerned that the Internal Revenue Service might flag him for deducting a home office on his 2014 federal tax return.

While the home office once raised red flags, it no longer does. Basically, the IRS found it was spending way too much time and effort on a measly return. There were bigger fish to fry. With home offices, the agency finally figured out it was jumping over dollars to get to dimes.

Since 2013, the IRS has offered an optional deduction, capped at $1,500 per year based on $5 a square foot for up to 300 square feet.

Accountants say that the original rules for home offices simply became too complex for the nearly 3.4 million taxpayers who claimed deductions for business use of a home.

In addition, there were grumblings about the amount of tax due when the home is sold because of depreciation recapture. According to Rob Keasal in the Seattle accounting office of Peterson Sullivan, the option does 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 “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 2013 option provides eligible taxpayers an easier path to claiming the home office deduction. The original method 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.

If you have a home office and use it as such, you know longer have to fear claiming it as a deduction.

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