Maximize tax benefits on 2015 returns
For a small-business owner who works out of his or her personal residence, a home-office deduction can provide significant tax savings, year in and year out. But keeping detailed records is critical. Although you may elect to use a simplified method for deducting home-office expenses on your 2015 tax return, the actual expense method usually produces a bigger deduction.
Background: To qualify for home-office deductions, you must use the office regularly and exclusively as your principal place of business or a place where you meet or deal with customers, clients or patients in the normal course of business. In addition, if you are an employee of a company, you must use the home office for the convenience of your employer.
For instance, if you are self-employed and you run your business from home, you will generally qualify for home-office deductions. But if you merely bring work home from your office on weekends, you are not likely to realize any tax benefits.
Actual expense method: Normally, a home-office deduction includes direct expenses attributable to the office, plus a proportionate share of indirect expenses such as mortgage interest, property taxes, utilities, repairs and insurance. Caveat: Mortgage interest and property taxes are generally tax-deductible anyway. The deduction available for indirect expenses is based on the percentage of your home used for business purposes. Also, you may be entitled to a depreciation deduction for the part of the home used as an office.
However, this method requires you to keep detailed records of expenses. As an alternative, the IRS offers a streamlined option.
Simplified method: All you have to do is figure out the square footage of the part of your home used as an office. Then, you can deduct $5 per square foot, up to a maximum of $1,500.
Nevertheless, when you compare these two methods, the actual expense method may produce a bigger deduction. If you have the necessary records, you might choose to bypass the simplified method.
Hypothetical example: A self-employed taxpayer uses a home office as her principal place of business. The home is 3,000 square feet and the home office is 300 square feet, or 10% of the home. Let’s say that the taxpayer has $2,000 in direct home-office expenses plus indirect expenses—including utilities, insurance and repairs—of $10,000 for the year (disregarding mortgage interest and property taxes that would otherwise be deductible). According to the IRS table, she is also entitled to a $400 depreciation allowance.
Based on these facts, the taxpayer can deduct $2,000 in direct expenses, $1,000 in indirect expenses and $400 in depreciation, for a total of $3,400. With the simplified method, her deduction is limited to $1,500, less than half the total with the actual expense method.
Note that you may switch between the actual expense and simplified methods from year to year. You are not locked into either method.
Do not make any costly assumptions or rash decisions. Compare the deduction available with each method to see which way you come out ahead. A professional tax return preparer can provide the necessary assistance.