by Jonathan Medows
A nice home office is often one of the most favored perks of being a freelancer—especially if you work at home full-time. Having a home office can also provide you with a significant tax deduction, if you qualify for it. Up until this tax year, the calculation necessary to claim the home office deduction was somewhat complex and required meticulous record keeping which meant that sometimes those who qualified for the deduction found it a hassle to calculate (it requires a separate form, Form 8829), or claimed an inaccurate amount. The good news is that starting with your 2013 tax return, the IRS has introduced a simplified method for calculating the home office tax deduction. But this new deduction raises the question—should you use it, or stick with the old “actual expenses” method?
Is the New Simplified Home Office Deduction Better Than the Old One?
In a nutshell, the new simplified home office deduction allows individuals who have a legitimate home office (see the definition of this below) to take a tax deduction of up to $1,500. To calculate this deduction multiply the square footage of your home office space by $5, to a maximum of 300 square feet, or $1,500. The deduction is then entered on Schedule C, of your 1040 return. The main benefit of this new deduction is its simplicity: You don’t have to provide any documentation to claim it, unlike the old “actual expense” method which involves calculating, allocating, and substantiating your actual expenses.
If you use the simplified method, you can also deduct your mortgage interest and real estate taxes separately on Schedule A–assuming you itemize. However, because it imposes a cap of $1,500 and eliminates the opportunity to deduct depreciation or carryover any losses from a previous year, this new deduction may not necessarily be the best option—especially if you can claim a higher amount using the actual expense method and you keep good records of your eligible home office expenses such as mortgage interest, insurance, utilities, repairs, and depreciation.
In contrast, the actual expense method allows deductions for a home office that are based on the percentage of your home devoted to business use. So, if you use a whole room or part of a room for conducting your business, you will need to figure out the percentage of your home devoted to your business activities. The bigger your home office is, and the more eligible expenses you have, the more likely the actual expense method will yield a larger tax break than the $1,500 ceiling imposed be the new simplified home office deduction. As a freelancer, you should be keeping track of your business expenses anyway, so it is worth trying the actual expense method of calculating your home office deduction if you believe that it will further reduce your tax burden.
Remember, You Still Have to Qualify for the Home Office Deduction
Of course, prior to deciding whether to use the new simplified home office deduction or the actual expense method, you need to make sure that the space that you call your home office meets the IRS definition of such. As a refresher, according to the IRS to be able to claim a home office deduction, you must meet the following requirements:
A portion of your home must be used in the course of your trade or business, and your use of the home office has to be regular and exclusive, which means that the space claimed as a home office must be used solely in connection with a trade or business that you conduct frequently. If the space is used partly for business use and partly for personal use, then the home office deduction does not apply to that space.
You must also: a) use your home office as your principal place of business; or b) use it to physically meet with clients, patients or customers; or c) use a home office that is detached from your home.
For this tax year, it may be worthwhile comparing the size of the deduction you can take using both the new simplified method and the actual expense method. It is important to note that with either method, you can only reduce your business income to zero; you can’t take a loss. However, if you find that you prefer one method over the other, or you think that you will exceed the $1,500 allowed by the simplified method one year, but not the next, you can switch the method from year-to-year.
Jonathan Medows is a New York City based CPA who specializes in taxes and business issues for freelancers across the country. His website, www.cpaforfreelancers.com, has a resource section with how-to articles and information for freelancers.