PHOTO COURTESY OF STOCK.XCHENG/CARL DWYER.
The Internal Revenue Service recently announced (IR-2013-5) a new, simplified option that turf professionals who use a home office, as well as owners of home-based landscape and lawn care businesses, may use to figure their deductions for the expenses of operating that home office. This means that the nearly 3.4 million taxpayers who claimed deductions for the business use of their homes in 2010 (the last year when figures are available) can, hopefully, deduct up to $1,500 and save the countless hours of recordkeeping, calculation, allocation and substantiation required to meet many of the tax law's requirements for the home office expense deduction.
Although introduced at the height of the confusion with the introduction of the so-called "Fiscal Cliff" taxes, in the midst of the filing "season" for 2012 tax returns, this new option is available starting with the 2013 tax return filed by most professionals early in 2014. The new optional deduction is based on $5 per square foot, up to 300 square feet, with a cap of $1,500.
The tax rules clearly state that no deduction is allowed for the business use of a dwelling unit that is also used by the taxpayer as a residence during the tax year. Fortunately, there are exceptions that allow direct expenses and the business-use part of any indirect expenses related to business usage to be deducted - if certain strict requirements are met.
In general, home office expenses are deductible if part of the home is used regularly and exclusively as a principal place of business, a place to meet or deal with customers or clients in the ordinary course of business, or in the case of a separate structure that is not attached to the dwelling unit, in connection with the taxpayer's trade or business. These requirements still apply under the new option.
Taxpayers who are employees must meet an additional test - their use of the home office must be for the convenience of the employer.
The new home office expense option
To reduce the administrative, recordkeeping and compliance burdens of determining deduction allowed for the qualified business use of a residence, the IRS's new "Safe Harbor" allows a turf care professional, whether a worker, an employee of his or her own business, or the owner of a home-based landscape or lawn care business to use a flat, no-questions-asked deduction. This can be accomplished by multiplying a prescribed rate ($5) by the square footage of the part of the residence that is used for business purposes, not to exceed 300 square feet, for a maximum deduction of $1,500.
Naturally, the new safe harbor for home office expenses doesn't apply to an employee with a home office if he or she receives advances, allowances or reimbursements for expenses under a reimbursement or other expense allowance arrangement with an employer.
Homeowners using the new option cannot depreciate the portion of the home used in a trade or business. Of course, business expenses unrelated to the home, such as advertising, supplies and wages paid to employees, remain fully deductible. Furthermore, a turf care professional itemizing his or her deductions and who uses the safe harbor method for a taxable year may deduct any expenses related to the home that are deductible regardless of whether there is a qualified business use of the home (for example, deductions for qualified residence interest, property taxes and casualty losses).
An additional side benefit of using the safe harbor is that claiming a home office deduction will likely be less of an audit flag. 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. But reduced audit risk or not, is the safe harbor the most rewarding path?
An expensive home office
The tax write-off for the expenses of maintaining an office in the home involves not one expense, but many. These deductions - that may include such items as a portion of utility bills, mortgage interest, repairs and depreciation - are totaled up to get an overall reportable deduction.
According to the IRS, the home office tax deductions will depend on two things: (a) whether the expense is direct, indirect or unrelated; and (b) the percentage of the home used for business.
Direct expenses are the expenses directly related to the business use of the home, such as painting of the home office. These types of expenses are deductible in full, subject to the deduction limit on business income.
Indirect expenses, such as insurance, utilities and general repairs, are deductible based on the percentage of the home used for business. These expenses are indirectly related to business use of the home office; rather, they relate to the entire home. Thus, if only 25 percent of the home is used as a place of business, only 25 percent of net rent or repairs can be deducted.
Unrelated expenses, or expenses for the parts of the home not used for business, are not deductible. Landscaping or lawn care, for example, cannot be deducted even if done to enhance the look of the business and home office (unless, of course, the taxpayer is in the landscaping business).
- Rent: Rent is considered an indirect expense with the business portion deducted by anyone meeting the home office requirements. Those owning their home cannot deduct the fair rental value of the home office. Rather, they claim depreciation on the home office.
- Insurance: A portion of homeowners or renters insurance is deductible by those qualifying for a home-office deduction, equivalent to the percentage of the home used for business. However, if there is additional coverage directly related to the home office, the additional expense is treated as a direct expense.
- Casualty Losses: These are losses from fire, storm, theft, shoplifting or vandalism. What can be deducted as part of the home business deduction usually depends on the property affected. If it is a direct expense, meaning the loss is on the portion of the property used solely for business purposes, the entire loss can be deducted. If the loss involves property used for both business and personal purposes, such as a leak in the roof of the house, only the percentage of business use will be deductible.
- Security: The business portion of amounts spent for the installation of a security system that protects the home's windows and doors can be deducted. The business portion of the monthly monitoring fees is an indirect expense.
- Repairs: The cost of repairs, supplies and labor related to business use, such as the cost to repair the air-conditioning system of the house, are deductible. Since repairing the air-conditioning system benefits the entire house, and the home office, the deduction equals the percentage of home office use.
- Utilities and Services: The IRS primarily considers expenses for utilities and services, such as electricity, gas, trash removal and cleaning services, as personal expenses. However, deducting the business part of these expenses by those meeting the home office requirements is acceptable.
- Property Taxes: A percentage of home property taxes can be claimed only if home office expense deduction is allowed.
One important caveat: Although the home office rules apply to sole proprietors, partners, owners of S-corporations and members (owners) of LLCs, these rules do not apply to lawn care and landscaping businesses incorporated as regular "C" corporations. Home office deductions are reported on Form 8829, "Expenses for the Business Use of Your Home."
Benefits and pitfalls
Establishing a home office creates a secondary benefit: The ability to deduct travel expenses from home to business locations and back again. Since the home becomes a business location, driving from it to see a customer or vendor and returning home is a legitimately deductible business expense.
For those who own their home, claiming a home office deduction does not prevent them from claiming the home sale exclusion to avoid tax on gain up to $250,000 ($500,000 on a joint return). Naturally, any depreciation claimed with respect to the home office after May 6, 1997, must be "recaptured" or paid back, at the rate of 25 percent. This means the amount of depreciation reported is recaptured and one-quarter of it must be "recovered" and paid back in taxes.
An increasing number of turf care professionals work at home or operate a business from their home. Now they have the option of a new "safe harbor" deduction for home office expenses. Regardless of whether a home office is used for the convenience of an employer, a landscaping or lawn care business that is based in a home office, or the home office is used to supplement the business's primary place of business, a tax deduction may be available. This will allow everyone sufficient time to decide whether the safe harbor or deducting the actual expenses connected with maintaining a home office will be more advantageous for the 2013 tax year and the years that follow.
Mark E. Battersby is a tax consultant in Ardmore, Pa., as well as a freelance writer specializing in business and tax issues. Reach him at firstname.lastname@example.org.