Safe harbor provides simplified option for claiming home office deduction

Rev Proc 2013-13, 2013-6 IRB, IR 2013-5

In a Revenue Procedure, IRS has provided an optional safe harbor method that individuals can use to determine the amount of their deductible home office expenses, effective for tax years beginning on or after Jan. 1, 2013. The safe harbor-$5 × square feet of qualified use (up to 300 square feet)-provides an alternative to the calculation, allocation, and substantiation of actual expenses required under Code Sec. 280A.

Background. The general rule under Code Sec. 280A(a) is that no deduction is allowed for the business use of a dwelling unit that’s also used by the taxpayer as a residence during the tax year. But under exceptions, if strict requirements are met, deductions are allowed for direct expenses and the business-use part of the indirect expenses relating to business use of a residence:

… Home office expenses are deductible if part of the home is used regularly and exclusively as (1) a principal place of business, or (2) a place to meet or deal with customers or clients in the ordinary course of business. Taxpayers who are employees must meet an additional test-their use of the home office must be for the convenience of the employer. (Code Sec. 280A(c)(1))

… Expenses that are allocable to space within the dwelling unit used on a regular basis for the storage of inventory or product samples held for use in the taxpayer’s trade or business of selling products at retail or wholesale are deductible if the dwelling unit is the sole fixed location of the trade or business. (Code Sec. 280A(c)(2))

… Expenses that are attributable to the rental of the dwelling unit or a part of the unit are deductible. (Code Sec. 280A(c)(3))

… Expenses that are allocable to the part of the dwelling unit used on a regular basis in the taxpayer’s trade or business of providing day care for children, for individuals who have attained age 65, or for individuals who are physically or mentally incapable of caring for themselves are deductible. (Code Sec. 280A(c)(4))

These deductions are limited to the activity’s gross income reduced by all other deductible expenses that are allowable regardless of qualified use (e.g., mortgage interest, real estate taxes, and casualty losses) and by the business deductions that aren’t allocable to the use of the home itself (e.g., expenses of advertising, wages, and supplies). Expenses disallowed solely because they exceed business income can be carried forward, subject to the gross income limitation in the later year. (Code Sec. 280A(c)(5))

New safe harbor. To reduce the administrative, recordkeeping, and compliance burdens of determining the allowable deduction for the qualified business use of a residence under Code Sec. 280A, Rev Proc 2013-13 provides a safe harbor method under which an individual determines his allowable deduction for the qualified business use of a home by multiplying a prescribed rate ($5) by the square footage of the part of this residence that is used for business purposes, not to exceed 300 square feet, for a maximum deduction of $1,500. “Qualified business use” for this purpose is a business use that satisfies the requirements of Code Sec. 280A(c)(1) through Code Sec. 280A(c)(4)-that is, uses for which a deduction under Code Sec. 280A would otherwise be allowed. The $5 rate may be updated from time to time, as warranted. Adjustments are provided for determining the allowable square footage for a taxpayer with a qualified business use of a home for only a part of a year. (Rev Proc 2013-13, Sec. 3, Rev Proc 2013-13, Sec. 4 )

checkRIA observation: While taxpayers claiming a home office deduction under the safe harbor must still satisfy all the requirements under Code Sec. 280A (e.g., the deduction can still only be claimed for a part of the home used exclusively on a regular basis for business purposes), the safe harbor will substantially reduce taxpayer’s recordkeeping burden.

checkRIA observation: An additional side benefit of using the safe harbor is that claiming a home office deduction will likely be less of an audit flag for taxpayers. With the issues that arise in calculating, allocating and substantiating deductible expenses being resolved by the safe harbor’s formula, there are fewer issues that might prompt an IRS examination.

For purposes of the safe harbor, “home” means a dwelling unit used by the taxpayer during the tax year as a residence (as defined in Code Sec. 280A(d) and Code Sec. 280A(f)(1)), including a dwelling unit leased by a taxpayer. However, only a dwelling unit that is Code Sec. 1250 property (generally depreciable real property) and MACRS property (generally defined in Reg. § 1.168(b)-1(a)(2) as tangible, depreciable property subject to Code Sec. 168 that is placed in service after Dec. 31, ’86) qualifies as a home. (Rev Proc 2013-13, Sec. 3.03)

The safe harbor method doesn’t apply to an employee with a home office if he receives advances, allowances, or reimbursements for expenses related to the qualified business use of the employee’s home under a reimbursement or other expense allowance arrangement with his employer. (Rev Proc 2013-13, Sec. 4.01(4))

The safe harbor is an alternative to deducting actual expenses. Accordingly, a taxpayer electing the safe harbor method for a tax year generally can’t deduct any actual expenses related to the qualified business use of that home for that tax year, with the following exceptions:

Otherwise allowable home-related deductions. A taxpayer who itemizes deductions and uses the safe harbor may deduct any allowable expenses related to the home that are deductible without regard to whether there was a qualified business use of the home for that tax year (e.g., deductions for qualified residence interest, property taxes, and casualty losses). Taxpayers using the safe harbor method deduct these expenses as itemized deductions on Form 1040, Schedule A, and cannot deduct any part of these expenses from the gross income derived from the qualified business use of the home-either for purposes of determining the net income derived from the business or for purposes of determining the gross income limitation under Rev Proc 2013-13, Sec. 4.08(2) (which parallels the gross income limitation under Code Sec. 280A(c)(5)). Taxpayers with a qualified business use of a home who also have a rental use of the same home under Code Sec. 280A(c)(3) must allocate a portion of these expenses to the rental use to the extent required under Code Sec. 280A and its regs. (Rev Proc 2013-13, Sec. 4.04)
Business deductions unrelated to qualified home use. A taxpayer using the safe harbor method for a tax year may deduct any allowable trade or business expenses unrelated to the qualified business use of the home for that tax year (e.g., expenses for advertising, wages, and supplies). (Rev Proc 2013-13, Sec. 4.05)
A taxpayer using the safe harbor for a tax year can’t deduct any depreciation (including first-year bonus depreciation) or Code Sec. 179 expensing for the part of his home that is used in a qualified business use for that tax year. (Rev Proc 2013-13, Sec. 4.06) If he calculates and substantiates actual Code Sec. 280A expenses for a later year, he must calculate the depreciation deduction by using the appropriate optional depreciation table applicable for the property in the manner described in Rev Proc 2013-13, Sec. 4.07(2), regardless of whether he used an optional depreciation table for the property in its placed-in-service year. (Rev Proc 2013-13, Sec. 4.07)

A taxpayer using the safe harbor method for a tax year can’t deduct any disallowed amount under Code Sec. 280A(c)(5) carried over from a prior tax year during which the taxpayer calculated and substantiated actual Code Sec. 280A expenses. He can deduct the carried-over amount in the next succeeding tax year in which he calculates and substantiates actual Code Sec. 280A expenses. (Rev Proc 2013-13, Sec. 4.08(3))

Electing the safe harbor. A taxpayer may elect from tax year to tax year whether to use the safe harbor method or calculate and substantiate actual expenses under Code Sec. 280A. A taxpayer elects the safe harbor by using the method to compute the deduction for the qualified business use of a home on his timely filed, original federal income tax return for the tax year. Once made, an election for the tax year is irrevocable. A change from using the safe harbor method in one year to actual expenses in a succeeding tax year (or vice-versa) isn’t a change in accounting methods. (Rev Proc 2013-13, Sec. 4.03)

checkRIA observation: Many taxpayers should do at least a rough computation of their home office deduction using their actual expenses to compare it to the amount that they would be allowed under the safe harbor. In some cases, use of the actual expenses-despite being more complex and burdensome-may yield a sufficiently larger deduction to be worth the additional effort.

References: For home office expenses, see FTC 2d/FIN ¶ L-1300 et seq.; United States Tax Reporter ¶ 280A4 ; TaxDesk ¶ 258,000 et seq.; TG ¶ 16041 .

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