The Internal Revenue Service recently released Revenue Procedure 2013-13 that provides a new safe harbor for home office deductions. This has the potential to make your calculations streamlined where it is difficult to determine a fair value deduction.
Generally speaking, Section 280A disallows any deduction for personal expenses associated with the taxpayer’s residence unless a portion of the home is used regularly and exclusively as a principal place of business, to deal with customers or clients in the ordinary course of business or in connection with the taxpayer’s trade or business.
Section 280A(c)(5) imposes a gross income limitation on the deduction. Direct expenses of the business portion of the dwelling are deductible in full, subject to the gross income derived from the business use. Typically, taxpayers will deduct a portion of their mortgage interest, taxes, insurance, utilities and depreciation based on the percentage of use of the business.
With the new Rev Proc 2013-13, the IRS has provided an optional safe harbor method to calculate the deduction. As of 1/1/2013, taxpayers are now permitted to deduct $5 per square foot of office space, up to a maximum of 300 square feet or $1,500. It further provides that the taxpayer can elect from tax year to tax year whether to us the safe harbor calculation or actual expenses incurred.
The safe harbor does not affect the determination of whether the deduction is justified. The taxpayer must still prove that a portion of the dwelling is used “exclusively and on a regular basis” as the principal place of business. As with all tax records, document your files.
Since it is possible to exchange your business use property upon the sale of your personal residence pursuant to Revenue Procedure 2005-14, this opportunity to defer capital gains tax and recapture of previously taken depreciation, should not be discarded regardless of the method used to determine the annual expense deductions.